Chapter 17 Flashcards
What is the most important factor underlying every investment decision?
Economic soundness
Which factors need to be taken into consideration when performing an investment analysis?
Land use controls (zoning laws)
Economic forces (population grown, taxation)
What are the benefits of being a real estate investor?
Income, equity build-up, tax benefits, prestige
What are the disadvantages of being a real estate investor?
Illiquidity of assets (can’t get money out quickly if needed), management expenses, need for expert advice
What are the types of investment properties?
Agricultural
Business (buying/managing a business)
Commercial
Industrial
Office
Residential
What is a real estate investment trust (REIT)?
Investment that allows groups of investors to pool their resources to invest in larger, professionally managed, income-producing properties such as office buildings, apartment complexes, retail centers
What is Amount realized, or net proceeds from a sale?
Sales price - cost of the sale
What is Cost Basis?
Original value of an asset for tax purposes, used to determine the gain or loss on the sale of the property
What is Adjusted Basis?
Amount invested in the property for tax purposes including any capital improvements which would lower the total amount in gains
What is Capital Gain/Loss?
Increase or decrease in value of a property when it is sold
What is Cash Flow?
Movement of money into or out of a business or investment, measured over a period of time
What is appreciation?
Increase in value of an investment over time
What is Tax depreciation (cost recovery)?
Income tax deduction that allows a taxpayer to recover the cost of investment properties over a number of years
What is Equity?
Difference between the current market value of a property and the amount the owner still owes on the mortgage.
Equity begins with the initial down payment
What is liquidity?
An asset’s ability to be converted quickly into cash without causing a significant movement in price and with a minimum loss of value
What is a Tax shelter?
Legal method of decreasing an investor’s taxable income, and therefore, how much they owe in taxes
What are the types of risks involved in real estate investment?
Static risk - can be offset by insurance (flood, fire, robbery)
Dynamic risk - caused by changes in the market conditions (financial, liquidity, interest rate, inflation)
What is Leverage?
The use of other people’s money (loans) to purchase investments
What are the types of leverage?
Positive - If the investment returns more to the investor than the cost of the loan
Negative - If the investment returns less than the cost of the loan
What are the types of operating expenses used to estimate value with direct capitalization?
Fixed expenses - does not change with occupancy
Variable Expenses - changes with occupancy
Reserve for replacements - set aside to replace items
Which items are not included in operating expenses?
Mortgage payments, capital improvements, personal expenses
What is the first step in evaluating an investment property?
Preparing an operating statement showing annual forecasts of income and expenses over a period of time
What is Cash throw-off or Before-tax cash flow? How is it calculated?
Net operating income - annual debt service
How is the operating expense ratio calculated?
Operating expenses / effective gross income
How is loan to value ratio calculated?
Loan / value of the property
How is profit or loss % calculated?
Amount made / Original amount paid
For how many years can a residential investment property owner claim depreciation of the property under current tax law?
27.5 years on a straight-line basis
For how many years can a non-residential investment property owner claim depreciation of the property under current tax law?
39 years on a straight-line basis
How much can a residential property investor deduct each year for tax purposes on a straight-line basis?
Basis for depreciation / 27.5
How much can a residential property investor deduct each year for tax purposes on a straight-line basis?
Basis for depreciation / 27.5
How do you determine the basis of depreciation for an investment property?
Total acquisition cost * % the improvement represents of the total investment
How much can a non-residential property investor deduct each year for tax purposes on a straight-line basis?
Basis for depreciation / 39
What is Capital gain?
Profit made when an income producing property is sold
What are the classifications of income under the tax reform act of 1986?
Active - salaries and wages
Passive - investments, like rental income
Portfolio - dividends
What is a tax-deferred exchange?
Method in which real estate investors defer capital gain by exchanging properties with another real estate investor
For which type of seller financing, is the capital gains tax spread out over several years?
Installment sale
What is a business enterprise?
Sale or lease of a business involving a transaction in excess of $200,000
What is a business opportunity?
Sale or lease of a business involving a transaction with a sales price of $200,000 or less
How is a business that is failing/closing appraised?
Liquidation value approach
The liquidation value is the value that is left after liquidating all the assets of the business and paying off all the debts
What is “goodwill” in a business appraisal?
Intangible value of the name of the business
What is Going Concern Value?
Value of a business that is still operating
How is a business owner’s equity calculated?
Assets - liabilities
