chapter 10: capital structure

Question 1

capital structure

Answer 1

The types and amounts of capital that are employed to finance a property

Question 2

optimal capital structure

Answer 2

The capital structure that achieves the maximum return on equity

Question 3

asset’s capital stack

Answer 3

the claims against an asset and the layers of capital

Question 4

which claim has the first right to receive operating cash flow and proceeds from a sale or liquidation?

Answer 4

The most senior claim

typically a first mortgage

Question 5

disadvantage of having the senior claim

Answer 5

also carries the lowest return

Question 6

which is the most senior claim on cash flow?

Answer 6

the fixed dividend on preferred stock

Question 7

the most junior claim on cash flow

Answer 7

the dividend on the common equity

Question 8

when you sell property, the full principal amount of all debt, along with any accrued interest, must be paid prior to what?

Answer 8

prior to any proceeds being distributed to the equity holders

Question 9

what happens when the sale of property does not bring enough money to repay all the debt

Answer 9

it must be paid in order of seniority

Question 10

if a junior claim has a maturity date earlier than the senior claim, who has priority on the repayment on debt?

Answer 10

the junior claim

Question 11

WEIGHTED AVERAGE COST OF CAPITAL (WACC)

Answer 11

the combined cost of the debt and equity employed to finance a property or entity

combines the cost of debt and the cost of equity in proportion to the amount of each present on the balance sheet

Question 12

how to calculate the weighted average cost of capital)

Answer 12

(Kd · D) + (Ke · E) - t

Kd: cost of debt

D: debt

Ke: cost of equity

E: equity

t: marginal tax rate

Question 13

how can negative leverage turn positive? can the opposite happen too?

Answer 13

if a property’s NOI improve

ye if property performance buggs

Question 14

who own the residual rights to all cash flow and liquidation proceeds after the creditors have been paid?

Answer 14

Equity holders

Question 15

what is the equity’s holder claim limited to?

Answer 15

It is limited only by the performance of the property

Question 16

why is leverage employed?

Answer 16

Leverage is employed to increase the yield on equity

Question 17

how does leverage increase the yield on equity?

Answer 17

If the return on the asset (ROA) is greater than the cost of debt (Kd)

Question 18

how does leverage decrease the yield on equity?

Answer 18

If the return on the asset (ROA) is lower than the cost of debt (Kd)

Question 19

how does one calculate leverage?

Answer 19

leverage = D / (D + E)

Question 20

how do you calculate ROA?

Answer 20

EBITDA/Total capital

Question 21

EBITDA

Answer 21

Earnings before interest, taxes, depreciation and amortization

Question 22

what is an after tax interest rate

Answer 22

the result of the property owner being able to deduct interest paid when calculating income subject to taxation

Question 23

when would you want a negative leverage?

Answer 23

Expect NOI to Grow

Need Cash to Acquire property

Question 24

when does the portion of a property’s operating cash flow required to service debt increase?

Answer 24

when the level of leverage increasea

Question 25

Mezzanine debt (mezz)

Answer 25

provides an additional level of capital beyond traditional senior secured or first mortgage financing has more flexible covenants has a higher level of risk than traditional financing and requires significantly higher return serves as bridge financing

Question 26

how does mezzanine financing serve as bridge financin?

Answer 26

it has short maturity has an expectation that the mezz will be refinanced once a new capital structure is implemented following asset stabilization or turn around

Question 27

when does the availability of mezz tend to diminish?

Answer 27

in troubled real estate markets

Question 28

Wrap-Around Debt

Answer 28

you already got a first mortgage, but another mans gives you a second one when the maturity of the first comes to an end, the second mans pays for it, making him the only man you owe to both debts

Question 29

Participating Loans

Answer 29

give the lender an additional return based on the performance of the underlying asset

Question 30

what is the additional return of a participating loan based on?

Answer 30

annual operating performance proceeds from enhanced valuation at maturity or both

Question 31

Fixed participations

Answer 31

generally stated as a set percentage of profits after payment of the base interest rate

Question 32

Variable participations

Answer 32

call for the lender to be paid a variable percentage of earnings before taxes and net sale proceeds The percentage depends on how well the property performs

Question 33

Convertible Loans

Answer 33

allows the lender to exchange all or a portion of their note for an equity interest in the asset if the asset performs poorly, the lender will seek a return of their principal at maturity If the asset performs well, the lender will convert their note into an interest in the asset

Question 34

preferred equity

Answer 34

receive dividends and liquidation proceeds before any funds are paid to common equity holders senior to common equity dividends paid at stated rate which is bigger than the ones of common shares this dividend remain the same amount over time, while the latter could boom with gyu performance

Question 35

cumulative preferred equity

Answer 35

Securities with an accumulation feature

Question 36

conversion rights

Answer 36

allow the preferred shares to be exchanged into common shares at a set exchange ratio Some preferred equity structures may include this

Question 37

what are hybrids used for?

Answer 37

used to provide leverage for common equity holders beyond the level where traditional secured financing sources are prepared to lend given higher returns for the acceptance of the additional risk that comes with being subordinated to the senior lien holders

Question 38

sale leaseback

Answer 38

a transaction in which a property owner sells his or her asset to an investor and then leases it back from the investor

Question 39

benefits of a sale leaseback

Answer 39

allows the property owner to access the capital invested in the asset for other purposes while still maintaining the use of the property may also include a right for the seller to repurchase the asset at the end of a given period

Question 40

which types of properties are the best candidates for sale leasebacks

Answer 40

Corporate headquarters, chain stores, and restaurants

Question 41

bargain purchase clause

Answer 41

The price to reacquire the asset sold after a sale leaseback might be set at a low level to encourage the user to repurchase the property at the end of the lease

Question 42

land lease

Answer 42

ease a parcel of land under a long-term agreement that allows the lessee to build and utilize a structure on the land

Question 43

subordinated ground lease

Answer 43

If the land lease is made junior to the bank loan on the structure

Question 44

unsubordinated ground lease

Answer 44

. If the ground lease is senior

Question 45

why are unsubordinated ground leases very safe investments?

Answer 45

because neither the owners nor lenders on the improvements are likely to lose their assets to the ground lessor through a default

Question 46

why are subordinated ground leases a riskier investments?

Answer 46

because in order to preserve ownership of the ground, a lessor may need to repay the first mortgage on the improvements

Question 47

air rights

Answer 47

he property owner’s rights to develop additional space, typi- cally vertically, on an existing building

Question 48

mineral rights

Answer 48

the property owner’s rights to exploit any minerals that are located on a property

Question 49

Oil and gas rights

Answer 49

owner’s right to explore for, drill for, and exploit hydrocarbon reserves

Question 50

Water, riparian, and littoral rights

Answer 50

the ability of a landholder to use the water and the shoreline on or adjacent to their property