PROP 1023 / CHAPTER 8

Question 1

Define gross square footage?

Answer 1

ANSWER: Gross square footage includes all space within the exterior dimensions of a building

Question 2

Define net square footage?

Answer 2

ANSWER: Net square footage refers to usable space, excluding access space, servicing space, etc.

Question 3

The ratio of net to gross leasable space is referred to as the _ _ _ _ _ _

Answer 3

The ratio of net to gross leasable space is referred to as the efficiency ratio

Question 4

List 3 documents required when completing a commercial mortgage application?

Answer 4

1. Tenancy schedule
2. Property’s legal description
3. Building plans and specifications
4. Lease agreements
5. Credit references or annual reports of the tenants
6. Financial statements (outlining income and expenses, typically over the past three years

Question 5

What is a gross lease?

Answer 5

A gross lease (inclusive lease) is a lease in which the owner pays all or most of the property’s operating expenses and property taxes and applies primarily to residential apartments, older and/or smaller office buildings, and government leases

Question 6

What is a net lease?

Answer 6

A net lease is a lease in which the tenant typically assumes payment of a base rent and all property charges, such as taxes, insurance, utilities, repairs, maintenance, etc.

Question 7

What is a percentage lease?

Answer 7

A percentage lease is a lease where the tenant (usually in retail situations) is required to pay a specified percentage of gross or net sales made upon the premises. Sometimes a percentage lease is combined with a base rent (i.e., the greater of $10,000 per annum, or 12% of gross sales in excess of $100,000). There are many variations of percentage leases.

Question 8

_ _ _ _ _ _ _ _ _ is the expected annual gross income from the property, at 100% occupancy, based on the type of lease arrangements commonly used for this type of property.

Answer 8

Gross potential rental income is the expected annual gross income from the property, at 100% occupancy, based on the type of lease arrangements commonly used for this type of property.

Question 9

_ _ _ _ _ _ _ _ _ _ include those annual outlays which are necessary to the continued produc­tivity of the property and the maintenance of capital values, and which are the responsibility of the landlord.

Answer 9

Operating expenses include those annual outlays which are necessary to the continued produc­tivity of the property and the maintenance of capital values, and which are the responsibility of the landlord.​

Question 10

Operating expenses are stabilized or long-term averages and are divided into three categories:

[LIST 3]

Answer 10

Operating expenses are stabilized or long-term averages and are divided into three categories: fixed expenses, variable expenses, and replacement reserves.

Question 11

Explain how Net Operating Income is calculated?

Answer 11

Gross potential rental income minus allowances for vacancy and bad debts equals effective gross income. Effective gross income minus operating expenses equals the net operating income (NOI). It is the income which is available to service the mortgage debt and provide a return on equity.

Question 12

The _ _ _ _ _ _ _ ensures that the net operating income can cover the mortgage payments by expressing the margin between the net operating income and mortgage payments as a percentage of net operating income.

Answer 12

The safety margin ensures that the net operating income can cover the mortgage payments by expressing the margin between the net operating income and mortgage payments as a percentage of net operating income.

Question 13

What is the maximum annual debt service using the safety margin constraint?

Answer 13

Annual Debt Service = Annual NOI x (1.0 — Safety Margin)

Question 14

Many investors in income-producing properties find it financially advantageous to borrow a part of the required capital even though their own funds might be sufficient. There are several reasons which might lead to such borrowing: [LIST 4]

Answer 14

[1] Diversify investments and reduce overall risk

[2] When it is possible to borrow at an interest rate lower than the expected productivity of the enterprise. In these cases, the greater the debt, the higher will be the anticipated rate of return on invested equity capital (and of course, the greater the risk). This is called financial leverage or trading on the equity.

[3] The investor anticipates an increase in the general price level (inflation) and in the returns on real estate. In an inflationary environment, the purchase of property today with the use of debt financing may increase investment yields as the payments on the loan are fixed and the investor hopes to pay off the debt in “cheaper” (inflated) dollars.

[4] An investor may use debt financing to save or release equity for other activities, e.g., a merchandising or manufacturing concern may prefer to use available funds in a business rather than to invest it in land and buildings.

Question 15

While it is intuitively appealing to use the safety margin, the commonly used income constraint
is the _ _ _ _ _ _ _ ratio

Answer 15

While it is intuitively appealing to use the safety margin, the commonly used income constraint
is the debt coverage (or debt service coverage) ratio

Question 16

What is the formula for the Debt Coverage Ratio?

Answer 16

Debt Coverage Ratio = Annual NOI / Annual Debt Service

Annual Debt Service = Annual NOI / Debt Coverage Ratio

Question 17

What is the formula for determing the maximum loan according to the LTV constraint?

Answer 17

Maximum Loan = Loan-to-Value Ratio x Lending Value

Question 18

While lending practice with respect to owner-occupied residential property tends to be relatively uniform amongst mortgage lenders, the same cannot be said for commercial mortgage lending. There are several reasons why commercial lending activities are less uniform than residential lending activities. These include the following:

Answer 18

1. The properties used as security on the loan are much more diverse and unique in their characteristics.
2. The income on the property and the financial capacity of the commercial borrower — are much more diverse than the gross income used in residential underwriting.
3. The large size of commercial loans requires much more careful, detailed, and specific analysis
4. Commercial borrowers are generally more sophisticated with respect to financing than are typical residential borrowers. As a result, they may require and accept a greater diversity of financial arrangements than would be appropriate in the residential market.

Question 19

In commercial loan qualification, the lender will use two constraints. Identify the constraints? Which one is choosen?

Answer 19

In commercial loan qualification, the lender will use two constraints: a loan-to-value constraint and an income constraint and choose the lower of the two loans indicated.

Question 20

What is the formula to determine the lending value of an income producing property?

Answer 20

Lending Value = NOI / Market Capitalization Rate