HW Quiz 8 Flashcards
True or False: The extent to which one can leverage a real estate transaction with debt is generally tied to the current and anticipated future trajectory of real estate pricing.
True
Which investor(s) is/are non-taxable? (Select all that apply)
-pension funds
-commercial banks
-none of these
-private equity funds
-real estate developers
Pension funds are non-taxable entities
Combining the expected annual cash-on-cash yield with the expected annualized capital appreciation gives you a quick estimate of what?
Total annual return
True or False: The debtor is the lender, or the person who issues the debt
False
What is the phantom income problem?
Income that triggers taxes but has no real cash flow associated with it
The two components of total returns to equity are ______________, and ________.
capital appreciation, cash flow return
Capital appreciation is the return you earn as the building’s value increases, while the cash flow return is driven by the cash flows generated by the property, net of any debt service.
Select all of the primary reasons for borrowing:
-tax advantages
-diversify investment base
-enhance equity returns and capital appreciation
-more expensive than equity financing
-you want to increase equity returns without additional risk
-lenders are fun people to deal with
-you do not have sufficient funds to purchase the asset
-tax advantages
-diversify investment base
-enhance equity returns and capital appreciation
-you do not have sufficient funds to purchase the asset
Why do mezzanine loans carry higher interest rates than senior loans?
The mezzanine lender is taking on additional risk due to their subordination to the senior lender
-this additional risk is compensated for with higher interest rates
The terms positive leverage and negative leverage describe the effects of debt on cash returns. What are the metrics used in determining positive or negative leverage?
Annual property cash flow yield and annual interest rate
-Positive leverage simply means that the annual property cash flow yield % (NOI after normal reserves / Purchase Price) is greater than the annual interest rate paid to the lender. Negative leverage refers to situations where the property generates a lower cash flow yield than the interest rate.
The terms positive leverage and negative leverage describe the effects of debt on cash returns. What are the metrics used in determining positive or negative leverage?
Annual property cash flow yield and annual interest rate
-Positive leverage simply means that the annual property cash flow yield % (NOI after normal reserves / Purchase Price) is greater than the annual interest rate paid to the lender. Negative leverage refers to situations where the property generates a lower cash flow yield than the interest rate.
The largest portion of a real estate transaction’s capitalization is typically what?
Senior debt –typically 60-70% of the capitalization of a real estate transaction
True or False: Loan contracts trump bankruptcy law.
False
True or False: The lower the proportion of debt, the higher the expected equity appreciation return.
False
Positive leverage means that the property cash flow yield % (NOI after standard reserves / Purchase Price) is ___ the interest rate paid to the lender. Negative leverage means that the property cash flow yield % is ___ the interest rate paid to the lender
greater than, less than
What are the components of total returns to equity for real estate transactions? (Select all that apply)
-tax shield
-benefits of diversification
-cash-on-cash yield
-none of the options
-capital appreciation
-international rate of return
-interest cost
-treasury rates
-cash-on-cash yield
-capital appreciation
What is the difference between Chapter 7 and Chapter 11 bankruptcy? (select all that apply)
-Chapter 7 generally occurs before Chapter 11. If Chapter 7 does not present solutions, then you advance to Chapter 11
-None of the options
-Chapter 7 bankruptcy is more effective in retaining the faith of equity investors
-Chapter 7 creates tax liabilities from liquidating the firm’s assets
-Chapter 11 creates strategic opportunities
-Chapter 7 creates tax liabilities from liquidating the firm’s assets
-Chapter 11 creates strategic opportunities
How can diversification of a real estate portfolio potentially impact one’s investments? (Select all that apply)
-lowering your tax bill
-enhancing your revenues
-lowering your geographic, tenant, lease expiration, and asset risk exposure
-creating economies of scale
-enhancing your revenues
-lowering your geographic, tenant, lease expiration, and asset risk exposure
-creating economies of scale
Diversifying your real estate portfolio will not lower your tax bill. Instead, this results from borrowing, as interest payments can be deducted from your taxable income.
In a foreclosure sale, the first payment goes to:
-The government to settle any outstanding tax or environmental claims
-Unsecured debtors
-Lawyers and brokers hired in the foreclosure process
-None of these
-The senior lender to settle any outstanding debt
-The government to settle any outstanding tax or environmental claims
The government, as it has the “superposition”
Why might you choose a loan with negative leverage? (Select all that apply)
-To diversify your equity in other investments
-To juice your total equity returns
-To lower your risk
-None of the options
-You do not have enough equity
-To diversify your equity in other investments
-To juice your total equity returns
-You do not have enough equity
Once a defaulting borrower enters Chapter 11 bankruptcy (during the 180-day exclusivity period), who takes control of the borrower company’s business decision?
The borrower – one of the key provisions of the U.S. bankruptcy code is that once a borrower enters Chapter 11 bankruptcy, secured lenders cannot immediately seize their collateral. This is why people refer to “seeking bankruptcy protection.” U.S. bankruptcy law allows the defaulting borrower to remain in control of business decisions (subject to bankruptcy court oversight) until the point is reached when the bankruptcy court rules that either a successful reorganization has occurred or that a successful reorganization is impossible.
You buy Kathy Place in Year 0 for $500. You sell it in year 7 for $1,000. While owning the property without any debt, you made $50 a year. What is your annual return from property appreciation?
10.41%
A senior lender generally has the right to foreclose on the property if the borrower violates the terms of the loan agreement. In foreclosure, a lender with the first security position can take control of the property and auction it off. The sale proceeds will pay the following parties sequentially. (Seniority 1 to 5)
- government
- foreclosure lawyers and sale brokers
- senior creditor
- junior creditor
- common equity holder
True or False: Life companies are typically regarded as originating the lowest-risk loans.
True
Mathew Caplan Hotel and Resorts has a cash flow yield of 13%. Select all the scenarios where debt financing would create positive leverage.
-95% LTV loan at 8% interest
-10% LTV loan at 5% interest
-75% LTV loan at 9% interest
-1% LTV loan with 15% interest
-5% LTV loan at 14% interest
-None of the options
-95% LTV loan at 8% interest
-10% LTV loan at 5% interest
-75% LTV loan at 9% interest
A short sale is defined as:
A sale that does not generate enough proceeds to pay back the full owed amount
The real estate industry frequently uses the terms positive/negative leverage to describe the effects of debt on cash returns.
Positive leverage is achieved when a certain annual property return measure is higher than the annual interest rate paid to the lender. What is the definition of the return measure used in the positive leverage definition?
Cash flow yield % (NOI after normal reserves/purchase price)
What is mezzanine financing? (Select all that apply)
-None of the options
-Participating debt
-A variety of financing that is not straight debt or pure equity
-Junior debt
-Financing of the second floor of a building
-Convertible debt
-Preferred equity
-Participating debt
-A variety of financing that is not straight debt or pure equity
-Junior debt
-Convertible debt
-Preferred equity
Which of the following statements is true?
-Bankruptcy law is the same in the USA and UK
-Bankruptcy law is the same throughout the world
-Under Chapter 11 bankruptcy, the borrower does not have to pay interest on his loans
-Bankruptcy law is the same throughout Western nations
-Landlords are still paid during bankruptcy proceedings
-None of the above
-US bankruptcy law forbids debtors in bankruptcy to secure additional financing
-Under Chapter 11 bankruptcy, the borrower does not have to pay interest on his loans
How many days does U.S. bankruptcy law provide debtors to submit a reorganization plan?
180 days
If a property’s value has appreciated 24% over a two-year period, what is the compounded annual growth rate (CAGR)?
11.36
You purchased the Sterling Tower for $10 million and you believe that the building will increase 5% in value over the next year (in other words, the building’s value will be $10.5 million). If you plan to borrow 40% debt, what percentage is your estimated total equity return over the next year?
8.33
You purchased the Sterling Tower for $10 million. The building’s value has decreased by 10% over the past year (in other words, the building’s value is $9 million). If you have borrowed 20% debt, what percentage is your total equity return?
-12.50
The capital stack for a real estate transaction is formed from the following capital sources. Their value and interest rates are also given in the table. Please compute the Weighted Average Cost of Capital (WACC).
Capital stack
Sources of capital Value Interest Rate
Equity 1,000,000 19%
Debt - Mezzanine Loan 1,500,000 11%
Debt - Senior Secured Loan 7,500,000 6%
Total | Weighted Average 10,000,000 ?
8.05
