Chapter 4

Question 1

Describe three areas where value can be derived from an investment in commercial real estate property.

Answer 1

1) The properties ability to to create income
2) The expected sales price
3) For private, entrepreneurial investors, tax benefits may constitute a third source of value

Question 2

Explanation the relationship between GPI (Gross Potential Income), EGI (Effective Gross Income), and NOI (Net Operating Income).

Answer 2

GPI-income from property if rented at market rates

EGI=GPI-cost for vacancy or credit loss

NOI=GPI-operating expenses

Question 3

Discuss the difference between the cash basis accounting and accrual basis accounting.

Answer 3

cash-only recognizes income and expenses received and paid out
accrual-income and expenses posted when earned or incurred

Question 4

Describe how time affects the book value and equity appreciation (or depreciation) of a property.

Answer 4

As more time passes the book value become less representative therefore equity appreciation is commonly calculated on a quarterly basis.

Question 5

Discuss the process and assumptions used for determining DCF (discounted cash flow).

Answer 5

DF is determined by calculating NOI for a period of time (typically ten years) and then capitalizing to NOI at a determined rate in a stabilized year.

Question 6

Define IRR (Internal Rate of Return) and describe its relationship to investment analysis software.

Answer 6

The IRR is the actual rate of return on a series of cash flows generated by an investment. It is commonly used as a benchmark to evaluate the financial attributes of various investments.

Investment analysis software is used to calculate the IRR automatically, given stated parameters or assumptions. It is important to understand that the IRR can be misleading under certain circumstances such as with highly leveraged investments.

Question 7

How are real estate values typically categorized?

Answer 7

cash (income)

equity appreciation

Question 8

What is the equation for calculating value from net operating income and desired rate of return?

Answer 8

Value-NOI/rate of return (also called capitalization rate or yield)

Question 9

What are the five key components of Net Operating Income (NOI)?

Answer 9

*GPI-Gross Potential Income
*Vacancy
*Credit Loss-tenant charges to be written off as uncollectable
*EGI (Effective Gross Income)-GPI-vacancy-credit loss
Operating Expenses

Question 10

Describe the benefits of accrual basis accounting.

Answer 10

It helps to avoid anomalies that may be present with cash basis accounting.

Question 11

Describe two common factors used to calculate yield.

Answer 11

cash-on-cash return=cash return/cash invested

market-to-market basis-a factor that indicates that a property is adjusted to the current market value

Question 12

Explain GAAP (Generally Accepted Accounting Principles) formula for determining book value.

Answer 12

Book value is the value of property on a financial statement.

BV=original cost+cost of improvements-capital disposals-depreciation+income earned-cash received

Question 13

How does discount rate affect property value and risk?

Answer 13

discount rate-the rate of return in a DCF (discounted cash flow) analysis.

high discount rate results in lower property value and high risk.

also called yield rate

Question 14

Describe the advantages and disadvantages of using IRR (internal rate of return) to evaluate the financial attributes of various investments.

Answer 14

Advanatages

• most widely used
• simple to compute

Disadvantages

• can be misleading for highly leveraged properties
• assumes all cash flows are invested at the same rate

Question 15

Describe the relationship between the FMMR (Financial Management Rate of Return) and the IRR (Internal Rate of Return).

Answer 15

FMMR is a safe rate, compared to IRR, for which future cash flows are invested during a particular period

For FMMR, cash flow is invested at treasury bond rates rather than the IRR

Question 16

Describe how asset managers use investment analysis software.

Answer 16

It helps the asset manager balance trade offs of a transaction to maintain or enhance the value of a property.

Question 17

Identify typical data points needed to generate reports using asset management software.

Answer 17

inflation
lease rates
building areas (net rentable, usable, etc.)
tenant improvements and leasing commissions
vacancy allowance/credit loss
sales volume
downtime and rent abatement
revenues and expenses

Question 18

Describe a best practice for asset managers to ensure that a given property is performing according to standards.

Answer 18

Completing an operational review-at a minimum it should include a statement of income and expenses as well as a comparison of those figures to the budget.