Alternative Investments

Question 1

Real Estate Investments

Answer 1

• direct ownership includes a home or personal residence, an investment in raw land, and residential rental real estate
• indirect ownership includes real estate investment trusts (REITs), real estate limited partnerships (RELPs), and real estate mortgage conduits (REMICs).

Question 2

Net Operating Income (NOI)

Answer 2

• the net income (less fixed and variable operating expenses) before depreciation and mortgage debt service (interest and principal)
• generally used as the measure of income from residential real estate because it does not consider mortgage payments and depreciation.

Question 3

REITs

Answer 3

• distribute 90% of their net annual earnings to shareholders
• at least 75% of gross income be derived from real estate
• 75% of the REIT portfolio is invested in real estate, loans secured by real estate, mortgages on real estate, shares of other REITs, cash, or government securities
• there are at least 100 shareholders and that no more than half the outstanding shares may be owned by five or fewer individuals at any time during the second half of each taxable year
• The REIT is not engaged in speculative, short-term holding of real estate in order to sell for quick profits.

Question 4

Advantages of REITs

Answer 4

• Limited Liability
• No corporate-level tax, REIT shareholders avoid double taxation
• pooling of resources
• knowledgeable professional management
• record-keeping
• small denominations
• ability to leverage investments

Question 5

Disadvantages of REITs

Answer 5

• loss of control
• lower potential returns
• management fees and administrative charges
• no flow-through of tax benefits - losses cannot be passed through to investors
• dividends received generally no eligible for preferential tax rate.

Question 6

Real Estate Limited Partnerships (RELPs)

Answer 6

-a limited partner in a RELP is considered to be a passive investor and, therefore, any losses from the activity are subject to both the “at risk rules” and the “passive activity loss rules”

Question 7

Real Estate Mortgage Investment Conduits (REMICs)

Answer 7

• a self liquidating, flow-through entity that invests in real estate mortgages or mortgage backed securities
• the conduit terminates when the mortgages that constitute its corpus are repaid.
• investors can participate by the purchase of publicly traded debt securities or by buying privately placed residual interests.
• CMO is the most common

Question 8

Derivatives

Answer 8

• the value of the derivative depends on the value of another security, such as a listed stock.
• most common form is an option

Question 9

Futures

Answer 9

• an agreement between two parties to make or take delivery of a specified commodity or financial currency at a future date, place, and unit price.
• to complete the contract delivery of the commodity or asset may be made, but more often, the buyer of the contract (or holder) simply purchases an offsetting contract and cancels the original position.

Question 10

Warrants

Answer 10

• often attached to bonds

- allow the holder to purchase a specific number of shares of stock at a specific price for a specific period of time