Real Estate Finance & Investment Final Exam 2006

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Economics is greatly impacted by how well information travels through society. Today, social media giants Twitter, Facebook, and Instagram are major forces on the information super highway. (Credit: Johan Larsson/Flickr)

Decisions ... decisions in the social media age

To post or not to post? Every day we are faced with a myriad of decisions, from what to have for breakfast, to which route to take to class, to the more complex—“Should I double major and add possibly another semester of study to my education?” Our response to these choices depends on the information we have available at any given moment; information economists call “imperfect” because we rarely have all the data we need to make perfect decisions. Despite the lack of perfect information, we still make hundreds of decisions a day.

And now, we have another avenue in which to gather information—social media. Outlets like Facebook and Twitter are altering the process by which we make choices, how we spend our time, which movies we see, which products we buy, and more. How many of you chose a university without checking out its Facebook page or Twitter stream first for information and feedback?

As you will see in this course, what happens in economics is affected by how well and how fast information is disseminated through a society, such as how quickly information travels through Facebook. “Economists love nothing better than when deep and liquid markets operate under conditions of perfect information,” says Jessica Irvine, National Economics Editor for News Corp Australia.

This leads us to the topic of this chapter, an introduction to the world of making decisions, processing information, and understanding behavior in markets —the world of economics. Each chapter in this book will start with a discussion about current (or sometimes past) events and revisit it at chapter’s end—to “bring home” the concepts in play.

Introduction

In this chapter, you will learn about:

  • What Is Economics, and Why Is It Important?
  • Microeconomics and Macroeconomics
  • How Economists Use Theories and Models to Understand Economic Issues
  • How Economies Can Be Organized: An Overview of Economic Systems

What is economics and why should you spend your time learning it? After all, there are other disciplines you could be studying, and other ways you could be spending your time. As the Bring it Home feature just mentioned, making choices is at the heart of what economists study, and your decision to take this course is as much as economic decision as anything else.

Economics is probably not what you think. It is not primarily about money or finance. It is not primarily about business. It is not mathematics. What is it then? It is both a subject area and a way of viewing the world.


This course is an introduction to the most fundamental concepts, principles, analytical methods and tools useful for making investment and finance decisions regarding commercial real estate assets. As the first of a two-course sequence, this course will focus on the basic building blocks and the "micro" level, which pertains to individual properties and deals.

There are five parts to this exam, plus an extra-credit question.

The entire exam is designed to be finished in 2 hours, but you may take up to 3 hours.

No open books or notes are permitted, but some possibly useful formulas are given at the end.

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Real Estate Finance & Investment Final Exam 2
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22 Pages
2014
English US
Educational Materials



Sample Questions from the Real Estate Finance & Investment Final Exam 2006 Exam

Question: Suppose the riskfree rate of return is 3%, and the expected total return on the property free & clear is 7%, and you have a target total expected return of 11%. Assuming you can borrow at the riskfree rate, what Loan/Value ratio must you obtain for this real estate investment to meet your target expected return?

Choices:

0%

25%

50%

75%

80%

Question: Suppose a construction project anticipates end-of-month draws of $400,000, $300,000, and $600,000 consecutively. What will be the balance owed at the end of the third month if the interest on the loan is 7% per annum (nominal annual rate, compounded monthly), and no payments of either principal or interest are required during the construction period?

Choices:

$1,306,430.

$1,314,051.

$1,378,960.

Cannot be computed with the information given.

Question: A property has a McDonalds restaurant on it, which can earn $50,000 per year. In any other use (including another brand of restaurant), the most it can earn is $40,000 per year. Assuming a discount rate of 10% and constant cash flow in perpetuity, what is the "investment value" of this property to McDonalds, and what is its "market value"?

Choices:

Both investment value and market value are $400,000.

Both investment value and market value are $500,000.

Investment value is $400,000 and market value is $500,000.

Investment value is $500,000 and market value is $400,000.

Question: All of the following must be known (or assumed) in order to rigorously derive the real option value of a land parcel or development option, except:

Choices:

The current value of the underlying asset (the built property value, V0 )

The opportunity cost of capital (OCC) of the underlying asset ( rV )

The volatility of the underlying asset (s)

The payout rate (or current income yield rate) of the underlying asset ( yV )

Question: All of the following are typical types of real options found in development projects or developable land ownership, except:

Choices:

The wait option

The phasing option

The switch option

The refinance option

Question: Consider the investment evaluation of a real estate development in which the property to be built is projected to reach stabilized occupancy at the end of Year 2 (two years from the time the investment decision must be made and construction will begin). The project is speculative in that there are no leases signed as of Time Zero (the present, when the investment decision must be made). The property level opportunity cost of capital is considered to be 9% for stabilized investments, and 10% for assets not yet stabilized (lease-up investments). Which of the following is true?

Choices:

Property level before-tax cash flows beyond Year 2 should be discounted back to the end of Year 2 at 9%, and the projected stabilized asset value as of the end of Year 2 should be discounted two years to Time Zero at 10%.

Property level before-tax cash flows beyond Year 2 should be discounted back to the end of Year 2 at 10%, and the projected stabilized asset value as of the end of Year 2 should be discounted two years to Time Zero at 9%.

Property level before-tax cash flows beyond Year 2 should be discounted all the way back to Time Zero at the 10% rate.

Property level before-tax cash flows beyond Year 2 should be discounted all the way back to Time Zero at the 9% rate.

Question: Consider an 8.5% loan amortizing at a 25-year rate with monthly payments. What is the maximum amount that can be loaned on a property whose net operating income (NOI) is $500,000 per year, if the underwriting criteria specify a debt service coverage ratio (DCR) no less than 125%?

Choices:

$2,789,406

$3,409,091

$3,844,614

$4,000,000

$4,139,619

Question: An investor believes that a certain property is worth $10,000,000. The seller refuses to sell it for that amount, but has offered to provide a 5-year interest-only loan for $5,000,000 at 4% interest (annual payments at the ends of the years, first payment due in one year). Market interest rates on such a loan are currently 6.5%. How much should the investor be willing to pay for the property from an investment value perspective (taking the loan deal) if the investor faces a 30% marginal income tax rate? (Ch15)

Choices:

$10,000,000

$10,383,588

$10,403,023

$10,519,460

Insufficient information to answer the question.

Question: The opportunity cost of capital (discount rate) applicable on an unlevered basis to assets that are not yet leased up ("speculative built properties") is best described as:

Choices:

Usually about 50 to 200 basis-points above the OCC for the same property with stabilized occupancy, based in part on analysis of the "interlease" discount rate implied in the property market.

Usually about 300 to 500 basis-points above the OCC for the same property with stabilized occupancy, based in part on analysis of the "interlease" discount rate implied in the property market.

Usually about 50 to 200 basis-points below the OCC for the same property with stabilized occupancy, based on the typical upward slope of the yield curve in the bond market, because lease-up is near term.

Usually about 300 to 500 basis-points below the OCC for the same property with stabilized occupancy, based on the typical upward slope of the yield curve in the bond market, because lease-up is near term.

Question: For the same property as above, suppose the underwriting criteria is a maximum loan/value ratio (LTV) of 75%, and we estimate property value by direct capitalization using a rate of 11% on the stated NOI. By this criterion what is the maximum loan amount?

Choices:

$2,789,406

$3,409,091

$3,844,614

$4,000,000

$4,139,619

Question: Consider a 20-year (monthly-payment), 8%, $80,000 mortgage with 2 points prepaid interest up front. What is the yield to maturity?

Choices:

8.00%

8.12%

8.20%

8.27%

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Source:  Geltner, David, and Tod McGrath. 11.431J Real Estate Finance and Investment, Fall 2006. (MIT OpenCourseWare: Massachusetts Institute of Technology), http://ocw.mit.edu/courses/urban-studies-and-planning/11-431j-real-estate-finance-and-investment-fall-2006 (Accessed 1 May, 2014). License: Creative Commons BY-NC-SA
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