Deck 11: Nuts and Bolts for Real Estate Valuation: Cash Flow Proformas and Discount Rates

Question 1

Suppose the riskfree rate of return is 7%, and the expected total return on the property free & clear is 11%, and you have a target total expected return of 15%. 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?

A) 0%
B) 25%
C) 50%
D) 75%
E) 80%

Answer 1

C

Question 2

Suppose a property has a cap rate of 10% and you can borrow at a mortgage constant of 11%. If you borrow 75% of the property price, what will be your equity yield?

A) 7.00%
B) 8.25%
C) 10.00%
D) 11.00%
E) Cannot be determined from the information given.

Answer 2

A

Question 3

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)

A) $10,000,000
B) $10,383,588
C) $10,403,023
D) $10,519,460
E) Insufficient information to answer the question.

Answer 3

B

Question 4

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?

A) $1,306,430.
B) $1,314,051.
C) $1,378,960.
D) Cannot be computed with the information given.

Question 5

Phased risk regimes in development projects):

Question 6

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?

A) $2,789,406
B) $3,409,091
C) $3,844,614
D) $4,000,000
E) $4,139,619

Question 7

What are the major line items in the operating budget of a development project, and why does it usually make sense for such a budget to consider only a single year's operation of the building?

Question 8

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:

A) 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.
B) 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.
C) 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.
D) 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 9

Back-door feasibility analysis:

Question 10

A property has a McDonald's 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"?

A) Both investment value and market value are $400,000.
B) Both investment value and market value are $500,000.
C) Investment value is $400,000 and market value is $500,000.
D) Investment value is $500,000 and market value is $400,000.

Question 11

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

A) The wait option
B) The phasing option
C) The switch option
D) The refinance option

Question 12

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?

A) 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%.
B) 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%.
C) Property level before-tax cash flows beyond Year 2 should be discounted all the way back to Time Zero at the 10% rate.
D) Property level before-tax cash flows beyond Year 2 should be discounted all the way back to Time Zero at the 9% rate.

Question 13

The replicating portfolio of a development option land) consists of:

A) A long position in an asset like the stabilized building to be built and a short position borrowing) in a riskless bond.
B) A short position in an asset like the stabilized building to be built and a long position lending) in a riskless bond.
C) Long positions in both the stabilized building and a bond.
D) Short positions in both the stabilized building and a bond.

Question 14

Two loans have the same interest rate and maturity. Loan A has a 15-year amortization rate. Loan B has a 30-year amortization rate. In comparing these two loans from a borrower's perspective:

A) The advantage of Loan A is lower monthly payments and lower balloon payment at maturity.
B) The advantage of Loan B is lower monthly payments and lower balloon payment at maturity.
C) The advantage of Loan A is lower monthly payments but its disadvantage is a higher balloon at maturity.
D) The advantage of Loan B is lower monthly payments but its disadvantage is a higher balloon at maturity.

Question 15

Is it appropriate, and if so, why is it appropriate, to apply a riskless or nearly riskless OCC to construction cost cash flows in the typical development project?

Question 16

Why is it that construction loans are almost always used to finance all or most of the construction costs in a development investment, even when the investor has plenty of cash that could be used to pay for construction?

Question 17

Based on the following information, develop a front door "Simple Financial Feasibility Analysis" SFFA) for this project estimating the required minimum market gross rent per SF that will support development.
• 40,000 NRSF office building project.
• Acquisition & construction cost = $1,500,000;
• Estimated operating costs to landlord) = $100,000/yr.
• Projected stabilized occupancy = 95%.
• Permanent loan available on completion @ 9% interest-only loan) with 130% debt service coverage requirement on the net operating income, and 75% maximum loan-to-value ratio.
Show your work.

Question 18

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%?

A) $2,789,406
B) $3,409,091
C) $3,844,614
D) $4,000,000
E) $4,139,619