PROP 1020 / CHAPTER 2

Question 1

Annual potential gross income is _ _ _ _

Answer 1

Annual potential gross income is the expected rent at which the property can be leased on the assumed specified lease terms and at 100% occupancy.

Question 2

When you buy capital property for your business, you cannot deduct its entire cost as an expense for the year of purchase. Instead, you must claim the expense incrementally over several years. This amount is known as _ _ _ _ _ _ _ _

Answer 2

When you buy capital property for your business, you cannot deduct its entire cost as an expense for the year of purchase. Instead, you must claim the expense incrementally over several years. This amount is known as the capital cost allowance (CCA).

Question 3

Effective gross income (EGI) is _ _ _ _ _

Answer 3

Effective gross income (EGI) is the anticipated income from all operations of the real property AFTER an allowance is made for VACANCY AND COLLECTION LOSSES

Question 4

_________ are costs that, in the short-run, remain constant throughout the period, independent of the level of occupancy.

Answer 4

FIXED EXPENSES are costs that, in the short-run, remain constant throughout the period, independent of the level of occupancy.

Question 5

________ are defined as outlays that vary directly with the level of occupancy.

Answer 5

VARIABLE expenses are defined as outlays that vary directly with the level of occupancy.

Question 6

COMPLETE THE SENTENCE: Appraisers are typically concerned with ___________ on a _______ income tax, ______ financing basis.

Answer 6

Appraisers are typically concerned with “STABILIZED NET OPERATING INCOME” on a before income tax, before financing basis.

Question 7

In calculating a stabilized net operating income, appraisers typically include _____________.

Answer 7

In calculating a stabilized net operating income, appraisers typically include replacement allowance accounts (reserves for capital commitments)

Question 8

OER = ??

Answer 8

OER = TOE / EGI

Question 9

GIM = ??

Answer 9

GIM =
Sale or Purchase Price /
Effective Gross Income

Question 10

What is an escalator clause?

Answer 10

An escalator clause is a provision often made in respect of property taxes but it can also be applied to other services, which the lessor has agreed to supply.

It enables the landlord to increase the rent payable during the lease term by the same amount as the increase in the cost of the items covered by the escalation clause.

Thus, if property taxes at the beginning of the lease were $500, the inclusive rent was $2,000, and property taxes were later increased to $600, the lessor would be entitled to increase the rent to $2,100 a year.

Question 11

Explain the relationship between fixed expenses and risk.

Answer 11

One element of risk exposure is related to the relationship between fixed expenses, variable expenses and net operating income (NOI). The higher the proportion of fixed expenses, the higher the net operating income must be to cover the fixed and variable expenses, i.e., the higher the break-even point or the point where NOI is equal to zero.

Question 12

How is Before-Tax Cash Reversion calculated?

Answer 12

Gross Sale Price

− Commission

− Legal Fees

= Net Sale Price

• *− Outstanding Balance on Debt**
• *_______________**

= Before-Tax Cash Reversion

Question 13

How is tax on capital gain calculated?

Answer 13

Net Sale Price

• *− Adjusted Cost**
• *= Capital Gain**

× % Taxable

= Taxable Capital Gain
× Assumed Tax Rate
__________________

= Tax on Capital Gain

Question 14

Where the lessee is liable for all repair and maintenance costs, taxes, insurance and any other outgoings, the lease may be called a _ _ _ _ _ _.

Answer 14

Where the lessee is liable for all repair and maintenance costs, taxes, insurance and any other outgoings, the lease may be called a FULLY NET LEASE

Question 15

Your ________________ is the amount of the capital costs you have yet to claim as business expenses.

Answer 15

Your Undepreciated Capital Cost is the amount of the capital costs you have yet to claim as business expenses.

Question 16

How is Effective Gross Rent Calculated?

Answer 16

Potential Gross Rental Income

PLUSOther Income

MINUS Vacancy Allowance

MINUS Collection Loss Allowance

____________________

EQUALS Effective Gross Income

Question 17

Often commercial properties, namely industrial, retail and office reflect ___ leases whereas multifamily residential apartment buildings typically entail ____ leases where the landlord is responsible for all expenses (except where individual metering of some services applies).

Answer 17

Often commercial properties, namely industrial, retail and office reflect NET leases whereas multifamily residential apartment buildings typically entail GROSS leases where the landlord is responsible for all expenses (except where individual metering of some services applies).

Question 18

In preparing a pro-forma cash flow statement, the analyst must determine:

[list 3]

Answer 18

In preparing a pro-forma cash flow statement, the analyst must determine:

1. the appropriate investment horizon;

2. a set of forecasts for future cash flows up to the end of the investment horizon; and

3. a forecasted disposition price at the end of the investment horizon.

Question 19

_ _ _ _ _ _ _ _ is described as the typical expected annual income, and most appraisers agree that this should be calculated after replacement allowance since the exact timing of capital expenditures for replacement of fixtures cannot be reasonably forecasted.

Answer 19

Stabilized net operating income is described as the typical expected annual income, and most appraisers agree that this should be calculated after replacement allowance since the exact timing of capital expenditures for replacement of fixtures cannot be reasonably forecasted.

Question 20

How is the before tax cash reversion calculated?

Answer 20

BEFORE TAX CASH REVERSION

Gross Sale Price

− Commission

− Legal Fees

= Net Sale Price

− Outstanding Balance on Debt

= Before-Tax Cash Reversion

Question 21

COMPLETE THE SENTENCE

It is a standard practice to distinguish between outflows which are in the nature of an expense and _______ when incurred (or paid) and those which are in the nature of a capital expenditure. The full amount of capital expenditures cannot be deducted when they are incurred; rather they may be _______ or, in the case of land, may not be claimed as an expense at anytime.

Answer 21

It is a standard practice to distinguish between outflows which are in the nature of an expense and deducted in full when incurred (or paid) and those which are in the nature of a capital expenditure. The full amount of capital expenditures cannot be deducted when they are incurred; rather they may be expensed over time or, in the case of land, may not be claimed as an expense at anytime.

Question 22

TRUE OR FALSE?

The full amount of capital expenditures cannot be deducted when they are incurred.

Answer 22

ANSWER:

TRUE

Question 23

TRUE OR FALSE?

Land may not be claimed as an expense at anytime.

Answer 23

ANSWER: TRUE

Question 24

Detail how the after-tax reversion is calculated?

Answer 24

Gross Sale Price

− Real Estate Commissions

− Legal Fees

= Net Sale Price

− Outstanding Debt

= Pre-Tax Reversion

− Tax on Capital Gain

− Tax on Recapture

= After-Tax Reversion

Question 25

The _ _ _ _ _ _ _ _ _ is an indicator of the sensitivity to variations in rental income and different ratios of variable to fixed expenses;
it is an indicator of business risk.

Answer 25

ANSWER:

The degree of operating leverage is an indicator of the sensitivity to variations in rental income and different ratios of variable to fixed expenses;

it is an indicator of business risk.

Question 26

What is CCA recapture?

Answer 26

A recapture of CCA can happen if the proceeds from the sale of depreciable property are more than the total of the undepreciated capital cost of the class at the start of the period.

Question 27

____ is the tax equivalent of depreciation.

Answer 27

ANSWER: CCA is the tax equivalent of depreciation

Question 28

Explain the term “Stabilized NOI”

Answer 28

NOI when the Vacancy Rate reaches stabilization and when rent and expenses no longer change aside from inflation.

Question 29

Consider the following financial information for the current year for a small apartment building:

Purchase Price $500,000
Number of Units 25
Annual Rent per Unit $5,900
Vacancy Rate 4%
Collection Loss 2%
Variable Expenses per Unit per Year $1,675
Fixed Expenses per Unit per Year $2,070
24 units were occupied last year

Based on your estimate of this year’s net operating income and assuming no replacement allowance,
which of the following represents the gross income multiplier and overall capitalization rate,
respectively?
(1) 3.76; 9.96%
(2) 3.61; 9.34%
(3) 3.38; 9.93%
(4) 9.93%; 3.53%

Answer 29

Answer: 2
Gross Potential Rent ($5,900 × 25) $147,500
- Vacancy and Collection (6%) – 8,850
Effective Gross Income $138,650
- Fixed Expenses ($2,070 × 25) – 51,750
- Variable Expenses ($1,675 × 24) – 40,200
Net Operating Income $46,700
Calculation of the Gross Income Multiplier (GIM):
GIM = Purchase Price
Effective Gross Income
= 500,000 / 138,650
= 3.606 or 3.61%

Calculation of Overall Capitalization Rate (OCR):
OCR = Net Operating Income / Purchase Price
= 46,700
500,000
= 0.0934 or 9.34%