Real Estate Finance & Investments

Midterm I Group A
Name: ID#:
There are two parts to this exam. Financial calculator and 1 page (front/back) notes are
permitted.
Part I: Multiple Choice (10 Questions, 6 points each)
Select the best alternative answer in your judgement, based on what was taught in lectures, the
lecture notes, and the homework assignments. Clearly indicate your selection by lling in the
appropriate circle on the answer sheet. If your selection is not clear, no points will be awarded.
Read each question carefully before answering.
1. The equity REIT A currently (current time is end of 2013) trades at $100/share. In the
past year, the realized rate of return on A has been 35%, and As cap rate at the beginning
of year was 10%. REIT A distributed all of its NOI in the past year to its shareholders
in the form of dividends. What was the trading price of A at the beginning of 2013?
(a) $74
(b) $120
(c) $100
(d) $112
(e) $80
2. An apartment building has 100 identical units that rent at $25,000/year/unit. The rent
includes the utilities (variable operating expenses). The owner pays for the real estate
taxes (10% of property gross income), insurance ($20,000/year), and the utilities (variable
operating expenses, $1000/year/unit). On average, there is 4% vacancy. Currently, the
cap rates for such buildings are 10%. How much is the property worth?
(a) $10,805,000
(b) $9,765,345
(c) $20,340,000
(d) $19,800,000
(e) $15,652,460
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3. You are evaluating 5 dierent real estate investment opportunities around Southern Cal-
ifornia. As of the end of 2013, all properties are valued at $1 million, however properties
have dierent income proles that are given in the table below. Assuming that property
prices, rents, and expenses reect market fundamentals correctly, which property would
be the riskiest investment? Which one would be the least risky investment? (most risky
/ least risky)
Projected NOI Expected annual
(for 2014) growth in NOI
Property 1 $70,000 1%
Property 2 $60,000 3%
Property 3 $50,000 3%
Property 4 $40,000 4%
Property 5 $50,000 1%
(a) Property 1 / Property 4
(b) Property 2 / Property 5
(c) Property 3 / Property 2
(d) Property 4 / Property 1
(e) Property 5 / Property 3
4. An investor with a one year investment horizon purchases an industrial property for $1
million, nances 60% of the purchase with debt and 40% with equity. The borrowing rate
is 5%. The states of the world for the following year are summarized below:
Probability Property value Rent
25% $1,200,000 $100,000
50% $1,000,000 $100,000
25% $800,000 $80,000
All cash ows take place at the end of the year. What is the expected return on asset
(ROA) and expected return on equity (ROE) for this investor?
(a) 9.5% / 16.25%
(b) 6.5% / 20%
(c) 7% / 33.7%
(d) 10.25% / 18.5%
(e) 21% / 16.8%
5. Which of the following is true about the use of leverage in real estate?
(a) Financial leverage increases the risk of the equity investment.
(b) The greater the proportion of xed costs, the greater the nancial leverage.
(c) Financial leverage leads to variability in operating prots.
(d) For a given real estate asset, if the loan to value ratio and the risk of the equity goes
up, the weighted average cost of capital (WACC) also goes up.
(e) In property valuation, the cost of capital is the borrowing rate of the property owner.
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6. Which of the following observations would NOT imply low cap rates for apartments in
West Los Angeles?
(a) West LA apartments are not very susceptible to the economic conditions. People
need apartments even in recessions.
(b) Since West LA is space constrained, the supply of apartments is restricted, while the
demand for apartments is expected to rise.
(c) The Treasury bond yields are near historically low levels.
(d) The expected market risk premium is relatively high.
(e) Apartments are expected to have low returns.
7. Native Foods is a 20,000 sqf Southern California grocery store that generated $1200/sqf
of sales in 2013. The sales in the same location is expected to increase by 10% within the
next year (2014). Native Foods currently pays $40/sqf base rent and 4% percentage rent
above the natural breakpoint. Next year, the base rent will increase 25% to $50/sqf.
Which of the following statements is false regarding this stores lease?
(a) The natural sales breakpoint in 2013 is $1000/sqf.
(b) The total lease payment in 2013 is $48/sqf.
(c) The natural sales breakpoint in 2014 is $1250/sqf.
(d) The total lease payment in 2014 is $60/sqf.
(e) The expected growth in lease total payments (from 2013 to 2014) is less than 25%.
8. We are trying to determine the value of a Class A oce building in San Jose. We project
the NOI for this property to be $8 million in the rst year, and expect the NOI to go
up by 2% per year (indenitely). We secured a 10-year, 75% LTV loan from Bank of
America at 8% annual rate. The property portfolio of a REIT, Linden Realty, is mostly
composed of Class A oce buildings around Silicon Valley, and is comparable to this oce
building. Linden has expected equity returns of 12%, is 40% debt nanced (LTV = 40%),
and borrows at 7%. What is the value of this oce building?
(a) $133.3 million
(b) $100 million
(c) $166.7 million
(d) $225 million
(e) $200 million
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9. Which of the following is true while implementing discounted cash ow (DCF) analyses
for property valuation?
(a) The cap rate at the time of sale (going-out) is typically lower than the cap rate at
the time of purchase (going-in) since property prices typically go up over time.
(b) Income growth typically increases and expense growth slows down over the life of
the property.
(c) Properties that go through major renovations typically have lower cap rates.
(d) Property taxes and lease commissions are part of operating expenses.
(e) Investments with high leverage (LTV) typically have higher NPVs, therefore are
more protable.
10. Which of the following is true about the demand / supply in the real estate markets?
(a) Long run commercial real estate demand curve is at.
(b) Commercial real estate supply curve is most likely at in Manhattan, NY. (note:
Manhattan is an island.)
(c) A permanent increase in employment in Manhattan, NY leads to short term increases
in property rents, but no change in rents in the long run.
(d) If the marginal cost of developing a new building is at, a permanent increase in
employment does not have an eect on rents in the long run.
(e) Class A oce building asset market is segmented (not integrated) since only investors
in New York would be interested in investing in properties there.
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Part II: 2 problems, 20 points each.
Please solve the following problems. Show all your work. The clear and well organized solutions
will be graded more leniently. Read each question carefully before answering. Do NOT write
on the back of the papers.
1. As an analyst at Expert Advisors, you are about to evaluate an industrial complex near
Ontario Airport. The building is expected to bring a steady cash stream in the next 5
years. The PBTCFs in the next 6 years are projected to be $10 million per year, to be
paid in arrears, and the building is expected to be sold at the end of year 5. The cap
rate at the time of sale is projected to be 10%, and selling expenses will be 6% of the sale
price. Here is what you know about risks and returns. . .
Zero-coupon treasury bonds maturing in 1 year are selling for $97.1 per $100 of
par value; 2-year bonds are selling for $92.5 and 3 year bonds are selling for $86.4.
Beyond three years, the yield curve is at.
The asset beta of comparable properties is 0.8, the expected market risk premium is
5% per year.
(a) (10 points) Calculate the discount rate(s) that you will use in this property valuation.
(b) (10 points) The asking price for the property is $100 million. Is it a good investment
opportunity?
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You may continue your work here.
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2. A 100,000 square feet industrial property in Alhambra, CA is on sale for $24 million. The
current tenant just renewed the lease for the next 5 years (industry practice is 5 year lease
terms). The lease will go up by 1% per year (ination rate) during the lease term, net
$10/sqf in the rst year to be paid in arrears (also current market rent), but is expected
to be leased at the market rate once the current lease expires (the rent within future lease
contracts is also expected to go up at the rate of ination, 1% per year). The market rent
is expected to go up by 3% per year. Currently, the yield curve is at and the risk free
rate is 3% per year. The risk premium on industrial properties is 4%.
(a) What is the value of this oce building, assuming that the building will be held and
rented indenitely (perpetually)? Would you buy this property?
(b) How much is the building currently worth if you believe that you can sell this property
at the end of year 10 at 6% cap rate? If you believe this result, would you buy this
property?
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You may continue your work here.
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