Real Estate Finance & Investment Midterm Exam 2003

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Do you use facebook?

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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 two parts to this quiz, plus an extra-credit question.

The entire quiz is designed to be easily finished in 75 minutes.

No open books or notes are permitted.

Formulas that may (or may not) be useful in this exam . . .

a + da + d2a + . . . + dn-1a = a(1-dn)/(1-d).

PMT/(1+r) + PMT/(1+r)2 + . . .+ PMT/(1+r)n = (PMT/r)[1 – 1/(1+r)n].

CF + CF/(1+r) + CF/(1+r)2 + . . .+ CF/(1+r)n-1 = (1+r)(CF/r)[1 – 1/(1+r)n].

CF/(1+r) + (1+g)CF/(1+r)2 + (1+g)2CF/(1+r)3 + . . . (forever) = CF/(r-g).

EAY = (1+CEY/2)^2-1; MEY=((1+EAY)^(1/12)-1)*12.

PMT = PV*(i/m)/(1 – 1/(1 + i/m)^N); i=IntRate/Yr, m=Pmts/Yr.

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Real Estate Finance & Investment Midterm Exam
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31 Pages
2014
English US
Educational Materials



Sample Questions from the Real Estate Finance & Investment Midterm Exam 2003 Exam

Question: All of the following are fundamental causal determinants of cap rates in the property asset market, except:

Choices:

The opportunity cost of capital (as determined in the capital market).

The expected growth in property rents (as determined in the space market).

The risk perceived for the property (as determined in the space and capital market).

The net income divided by the property price.

Question: Suppose you analyze a particular deal and it appears that for an investment of $1,000,000 your client can obtain a positive NPV of over $500,000. Your client is typical of the type of high tax bracket individual investors who commonly purchase and sell this type of property, and indeed typically determine equilibrium prices in the asset market in which these properties are sold. What should you do?

Choices:

Reject the deal out of hand because it costs twice as much as its NPV.

Phone your client right away on your cell phone and urge her to pounce on this deal before it "gets away" - the seller must have made a mistake in their offering price!

Buy the property with cash, take out an 80% loan-to-value ratio mortgage, and laugh all the way to the bank with $200,000 of arbitrage profits!

Sharpen your pencil, double-check your assumptions and analysis, try to find what is unique about your client. (e) Cannot be answered from the information given.

Question: Which of the following is an example of "negative feedback" in the real estate system?

Choices:

Since the stock of built space cannot readily shrink, rents will fall when demand falls.

Lenders make money by issuing loans, so they tend to keep the capital flowing to developers even during down markets.

Real estate markets exhibit inertia, so market participants rationally extrapolate past rent trends into the future.

Growth in space usage demand stimulates increased rents or improved prospects for future rents, which increases the present value of real estate assets, which improves the profitability of new development projects.

Question: Suppose the lease on a certain space will expire at the beginning of 2001. You believe that the probability of the existing tenant renewing is 50 percent. If he renews, you will need to spend only an estimated $5.00/SF to upgrade his space. If he does not renew, it will take $25.00/SF to modernize the space, even then you expect 6 months of vacancy. What expected cash flow forecast should you put in year 2001 of your pro-forma for this space, if you expect triple-net market rents on new leases in 2001 to be $20/SF?

Choices:

$17.50/SF

$15.00/SF

zero

- $10.00/SF (e) Insufficient information provided to answer the question.

Question: Which statement is true ex ante?

Choices:

Leverage normally increases the owner's income return (cash yield) if you pay market value for the property.

Leverage normally increases the owner's income return (cash yield) if you pay more than market value for the property.

Leverage normally increases the owner's total return (including appreciation) if you pay market value for the property.

Leverage normally increases the owner's total return (including appreciation) if you pay more than market value for the property.

Question: You are trying to apply a multi-year DCF analysis to evaluate an investment property with some long-term leases in it. You observe that other properties with similar lease structure and risk have been selling at cap rates around 11% (based on NOI with no capital reserve). You believe these other properties typically face capital expenditures on the order of 1% of property value per year in the long run, and that given such expenditures their net cash flows and values would reasonably be expected to grow in the long run at about 3% per year. What discount rate should you apply to your subject property in your DCF valuation?

Choices:

The Treasury bond rate because of the long-term leases.

10%

13%

14% (e) Cannot be determined from the information given.

Question: Which of the following is true about typical real estate investment (unlevered, at the direct property level) and inflation risk?

Choices:

Real estate investment appreciation returns do not generally keep pace with inflation in the long run, but real estate investment provides a hedge against inflation risk in that unexpected changes in inflation tend to be positively correlated with changes in property value in the short to medium term.

Real estate investment appreciation returns generally at least equal the inflation rate in the long run, but real estate does not provide a good hedge against inflation risk in that unexpected changes in inflation do not tend to be positively correlated with changes in property value in the short to medium term.

Real estate investment appreciation returns generally at least equal the inflation rate in the long run, and real estate investment provides a hedge against inflation risk in that unexpected changes in inflation tend to be positively correlated with changes in property value in the short to medium term.

Real estate investment appreciation returns do not generally keep pace with inflation in the long run, and real estate does not provide a good hedge against inflation risk in that unexpected changes in inflation do not tend to be positively correlated with changes in property value in the short to medium term.

Question: Normally, one would expect what relation between the "going-in" and "going-out" cap rate?

Choices:

The going-in cap rate should be higher than the going out.

The going-out cap rate should be at least as high as the going-in rate.

There is no particular relation between the two.

Question: In which of the following situations would it be most appropriate to measure an investment manager's performance using the IRR rather than the time-weighted average periodic return?

Choices:

Client hires manager to place capital as soon as possible.

Client requires a large proportion of its invested capital to be liquid at all times for withdrawal on demand.

Client gives manager a line of capital with discretion over when to acquire and dispose of illiquid assets.

All of the above.

Question: Total development costs (including sufficient profit for the developers) are $200/SF. Cap rates in the asset market are 10%. What is the "replacement cost rent" in this market?

Choices:

$20.00/SF.

$16.00/SF.

$12.50/SF.

$10.00/SF.

Question: The expected return on an investment in a property is inversely related to the price you pay for the property fundamentally because:

Choices:

The future cash flows the property can generate are independent the price you pay for the property today.

The return must include a risk premium.

Inflation must be subtracted out.

The investor faces a budget constraint. (e) None of the above.

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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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