Royal University of Law and Econimics

Master of Financial Management

Subject: Real Estate Finance and Investment

Final Examination
Duration: 120 mn

I-True/False
1 Points are a one-time charge paid when the loan is obtained. The same dollar amount is paid
whether the loan is held to maturity or prepaid. The longer the loan is held, the more these costs are, in
effect, spread out over more payments. Conversely, if the loan is held for a shorter period of time, the
borrower does not get the full benefit of having paid these up-front costs.

Answer: True False

2 The payment savings resulting from the lower interest rate must be weighed against the costs
associated with refinancing such as points on the new loan or prepayment penalties on the loan being
refinanced.

Answer: True False

3 The balance of a loan depends on the original contract rate, whereas the market value of the
loan depends on the current market interest rate.

Answer: True False

4 An assumable loan allows the borrower to save interest costs if the interest rate is lower than
the current market interest rate. The investor may be willing to pay a higher price for the home if
the additional price paid is less than the present value of the expected interest savings from the
assumable loan.

Answer: True False

5 A buydown loan is a loan that has lower payments than a loan that would be made at the current
interest rate. The payments are usually lowered for the first one or two years of the loan term. The
payments are “bought down” by giving the lender funds in advance that equal the present value of the
amount by which the payments have been reduced.

Answer: True False

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6 Although the wraparound loan is technically a “second mortgage,” the wraparound lender is
only required to make payments on the existing mortgage if the borrower makes payments on the
wraparound loan. Furthermore, the wraparound lender is typically taking over an existing mortgage
that has a below market interest rate. Thus, the wraparound lender is benefiting from the spread
between the rate being earned on the wraparound loan and that being paid on the existing loan. This
allows the wraparound lender to earn a higher return on the incremental funds being advanced even if
the rate on the wraparound loan is less than the rate on a new first mortgage.

Answer: True False

7 If interest rates have risen significantly, the market value of the loan will be less. Thus, the
lender may be willing to accept less than the outstanding balance of the loan, especially if the lender still
receives more than the market value of the loan. The lender can then make a new loan at the higher
market interest rate.

Answer: True False

8 The home with an assumable loan might be expected to sell for more than comparable homes
with no assumable loans available when the contract interest rate on the assumable loan is significantly
less than the current market rate on a loan with similar maturity and similar loan-to-value ratio. Note
that if the dollar amount of the assumable loan is significantly less than that which could be obtained
with a market rate loan, the benefit of the assumable loan is diminished because the borrower may
need to make up the difference with a second mortgage.

Answer: True False

9 The incremental cost of borrowing funds is a measure of what it really costs to obtain additional funds
by getting a loan with a higher loan-to-value ratio that has a higher interest rate. This measure is
important because the contract rate on the loan with the higher loan-to-value ratio does not take into
consideration the fact that this higher rate must be paid on the entire loan - not just the additional funds
borrowed. Thus, the borrower should consider the incremental cost of the additional funds to know
what it is really costing to borrow the additional funds.

Answer: True False

10 The incremental cost of borrowing additional funds can be affected significantly by early
repayment of the loan, especially if additional points were paid to obtain the additional funds. Thus,
the borrower should consider how long he or she expects to have the loan when calculating the
incremental cost of the additional funds.
Answer: True False

11 Typically, the income approach is difficult to use because the sale of single family, rental properties
are rare in the area.

Answer: True False

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12 When using the market approach, the appraiser estimates the value of a property by comparing the
selling prices of properties similar to, and near, the property being appraised. Because no two
properties are exactly alike, the values of similar properties are adjusted by the appraiser for
dissimilarities. When using the cost approach, the appraiser established a value for the site on which
the improvement is located, then determines the cost of reproducing the improvements and adds the
two. After the costs of the improvement and land value are added, the appraiser deducts an amount for
any depreciation that improvements have suffered since they were constructed.

Answer: True False

13 List four important drivers of housing demand and price appreciation are Population growth, income,
households, price of rental housing

Answer: True False

14 Public goods include education, police, fire, health and other services provided by the local public
sector. To the extent the quality/value of these services provided to homeowners exceed the cost
(taxes, fees), paid, a net benefit is thought to exist. This net benefit is generally reflected in
land/property prices.

Answer: True False

15 Market research to determine an expected future price when the investor plans to sell and the title
search to determine any defects in the title and/or liens as well as the cost to clear the title.

Answer: True False

16 The rationale for using the cost approach to valuing (appraising) properties is that any informed
buyer of real estate would not pay more for a property than what it would cost to buy the land and build
the structure.

Answer: True False

17 The cost approach is most reliable where the structure is relatively new and depreciation does not
present serious complications.

Answer: True False

18 The rationale for the market approach (otherwise known as the sales comparison approach), lies in
the principle that an informed investor would never pay more for a property than what other
investors have recently paid for comparable properties.

Answer: True False

19 The sales comparison approach to valuation is based on data provided from recent sales of
properties highly comparable to the property being appraised.

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Answer: True False

20 For a property to be comparable, the sale must be an “arm’s-length” transaction or a sale between
unrelated individuals. Sales should represent normal market transactions with no unusual
circumstances, such as foreclosure, sales involving public entities, and so on.

Answer: True False

21 An overall rate or overall capitalization rate is the rate on the overall property (debt and equity).

Answer: True False

22 One way of arriving at an overall rate is to use the band of investment approach. This is based on
taking into consideration the investment criteria of both the lender and the equity investor involved in a
project. This is done by taking a weighted average of the equity dividend rate expected by the investor
and the mortgage loan constant (expressed on an annual basis) required by the lender.

Answer: True False

23 Two different ways of arriving at an overall rate are the direct capitalization approach and the
present value method.

Answer: True False

24 Using the direct capitalization approach, this technique is a very simple approach to the valuation of
income producing property. The rationale is based on the idea that at any given point in time, the
current NOI produced by a property is related to its current market value.

Answer: True False

25 Using the band of investment approach, the estimate of value under this approach is based on
current cash yields prevailing in the marketplace. This approach is not intended to provide investors
with estimates of long term rates of return on equity investments. Rather, these current yields are
intended to serve as market benchmarks that can be used in establishing property values.

Answer: True False

26 Appraisers often obtain capitalization rates by using information obtained from comparable sales,
i.e., they divide the property’s first year NOI by the reported sale price. While the appraiser may not
know what rate of return the investor is expecting or how the investor has projected income to change
over time, it is reasonable to assume that the capitalization rate implicitly reflects these investments
assumptions.

Answer: True False

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27 A capitalization rate is equal to the difference between the discount rate and the expected growth in
income. In other words, the change in income over the economic life of the property is ignored when
using a capitalization rate.

Answer: True False

28 A unit of comparison is used in the sales comparison approach to valuation. To the extent that there
are differences in size, scale, location, age, and quality of construction between the project being valued
and recent sales of comparable properties, adjustments must be made to compensate for such
differences. The appraiser must find an appropriate unit of comparison for a given property. Examples
are price per square foot for an office building, price per cubic foot for warehouse space, price per bed
for hospitals, or price per room for hotels.

Answer: True False

29 If perfect information was available, then theoretically the same value should result regardless of the
methods chosen, be it cost, market, or income capitalization. Even with imperfect information, there
should be some correspondence between the three approaches to value, which is the reason appraisal
reports will typically contain estimates of value based on at least two approaches to determining value.

Answer: True False

30 There are three categories of depreciation for the cost approach. They are very difficult to
determine and, in many cases, require the judgment of appraisers who specialize in such problems. The
three categories are Physical deterioration, Functional or structural obsolescence due to the availability
of more efficient layout designs and technological changes that reduce operating costs and External
obsolescence that may result from changes outside of the property such as excessive traffic, noise, or
pollution.

Answer: True False

31 A terminal cap rate may be lower than the going in cap rate if between the present time and end of a
holding period interest rates are expected to fall, risk is expected to decline, or demand is expected to
increase (thereby producing higher rents and/or appreciation). A higher terminal cap rate would result
if the opposite changes in the three situations stated above occurred.

Answer: True False

II-QCM
1 Which of the following is NOT fundamental in a loan refinancing decision?
*A)* charges associated with paying off the existing loan
*B)* the market value of the property
*C)* terms on the present outstanding loan
*D)* new loan terms being considered

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2 The amount that a new lender or investor would pay to receive the
remaining payments on the loan is referred to as:
*A)* effective cost of a loan
*B)* buydown loan
*C)* market value of a loan
*D)* origination fees
3 Which of the following is NOT an example of when seller financing most likely will take place?
*A)* seller of the house has a below market rate loan that could be assumed by the
buyer.
*B)* the seller increases the price of the house.
*C)* the seller finances at a higher rate than the market rate of the loan.
*D)* financing is difficult for the buyer due to higher interest rates and tight credit.
4 Which of the following is NOT representative of a buydown loan?
*A)* allows borrowers to qualify for the loan when their income might not meet
certain criteria by the lender.
*B)* effectively used during periods of high inflation.
*C)* they can be obtainable through home builders.
*D)* the home seller pays an amount to a lender to increase the interest rate on the
loan.
5 Which of the following is NOT a characteristic of wraparound loans?
*A)* the loan is obtained to get additional financing on a property while keeping an
existing loan in place.
*B)* the lender makes a loan for face value equal to the existing loan balance plus
any additional financing.
*C)* the borrower makes payments on existing loans.
*D)* the lender makes payments on existing loans.

1 Which of the following is not considered an influence on price appreciation?

*A)* current home price
*B)* interest rates
*C)* population growth
*D)* federal tax policy
2 Which of the following social trends has not contributed to the total increase in housing units?
*A)* delays in average marriage age
*B)* higher divorce rates
*C)* increasing life expectance
*D)* lower rates
3 When considering renting verses owning a property, which of the following is an important
consideration?
*A)* resale price of property if owned
*B)* current tax rates
*C)* insurance and maintenance

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 *D)* home ownership rates
5 Which of the following is not likely to be a reason for renting instead of owning?
*A)* lack of a down payment
*B)* the need for flexibility
*C)* low interest rates
*D)* home price bubbles
6 Which term properly refers to the relationship between the quality of services in a neighborhood or
municipality and the price paid to live in that area?
*A)* price to benefit ratio
*B)* capitalization effect
*C)* net capitalization
*D)* benefit appreciation
7 Which of the following is true of market value?
*A)* it is only of interest to the seller of a property.
*B)* it is used by the appraiser to establish home price.
*C)* it is the most probably price in a competitive market.
*D)* it is equal to the price.
8 Which of the following is NOT an approach used in an appraisal?
*A)* cost approach
*B)* income approach
*C)* sales comparison approach
*D)* price escalation approach
9 When an appraiser uses a discount rate to help value the subject property, the appraiser is using what
type of approach?
*A)* the cost approach
*B)* the price escalation approach
*C)* the income approach
*D)* the sales comparison approach
10 The final estimate of value given by the appraiser usually
*A)* applies a weight to all estimated values
*B)* is based on the income approach
*C)* tells you what you will get when you sell the property
*D)* is the highest value calculated

1 Which if the following is NOT a step in the appraisal process?

*A)* identify property rights to be valued
*B)* specify effective date of value
*C)* apply grantors principals
*D)* gather and analyze market data
2 What is the rationale for the sales comparison approach?
*A)* an informed investor would never pay more for a property than other investors
have recently paid

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 *B)* in a relatively short period of time, comparable houses in the same area will
always sell for the same price
*C)* value of property is related to its ability to produce cash flow through sales
*D)* the value of a property depends on its replacement cost
3 Gross income multiplier is defined as:
*A)* gross income/sales price
*B)* gross income/market value
*C)* sales price/gross income
*D)* market value/gross income
4 Which of the following is NOT true of capitalization rates?
*A)* it is equal to net operating income divided by transaction price
*B)* it assures the property will be a good investment if purchased
*C)* it is derived form comparable sales
*D)* it is noted in equations as "R"
5 Which of the following represents the present value of expected net operating income beyond the
holding period?
*A)* present value of future flows
*B)* holding period value
*C)* future net operating income
*D)* reversion value
6 Which of the following was not listed as a method of calculating real estate value when the subject
does not have comparable sales and has a very long economic life?
*A)* developing terminal capitalization rates on expected long term cash flows
*B)* extended economic life reversion
*C)* estimating terminal capitalization rate directly from sales transaction data
*D)* estimating resale price based on expected change in property values
8 Which of the following statements concerning mortgage-equity capitalization is NOT true?
*A)* it is a method for estimating value
*B)* it takes into consideration requirements by mortgage lender and equity investor
*C)* total value equals present value of expected mortgage financing and
present value of equity investment
*D)* it takes the total value and then is able to find the capitalization rates for
mortgage and equity
9 The text notes that higher market capitalization rates and therefore lower property values tend to be
brought about by:
*A)* unanticipated increase in the supply of real estate relative to demand
*B)* unanticipated increase in interest rates
*C)* both of the above
*D)* neither of the above
10 Which of the following is NOT harder to estimate using the cost approach for a property that is not
new?
*A)* replacement cost

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 *B)* physical deterioration
*C)* functional obsolescence
*D)* external obsolescence

III-Problem
Problem 1. An investor obtained a fully amortizing mortgage 5 years ago for $95,000 at 11 percent for
30 years. Mortgage rates have dropped, so that a fully amortizing 25-year loan can be obtained at 10
percent. There is no prepayment penalty on the mortgage balance of the original loan, but three points
will be charged on the new loan and other closing costs will be $2,000. All payments are monthly.
a. Should the borrower refinance if he plans to own the property for the remaining loan term?
Assume that the investor borrows only an amount equal to the outstanding balance of the loan.
b. Would your answer to part (a) change if he planned to own the property for only five more
years?

Problem2. You have an opportunity to acquire a property from First Capital Bank. The bank recently
obtained the property from a borrower who defaulted on his loan. First Capital is offering the property
for $200,000. If you buy the property, you believe that you will have to spend (1) $10,500 on various
acquisition-related expenses and (2) an average of $2,000 per month during the next 12 months for
repair costs, etc., in order to prepare it for sale. Because First Capital Bank would like to sell the property
as soon as possible, it is willing to provide $180,000 in financing at 8 percent interest for 12 months
payable monthly (interest only). Your market research indicates that after you repair the property, it
may sell for about $225,000 at the end of one year. Furthermore, you will probably have to pay about
$3,000 in fees and selling expenses in order to sell the property at that time.
If you wanted to earn a 20 percent return compounded monthly, do you believe that this would be a
good investment? If not, what counteroffer would you have to make First Capital in order to achieve the
20 percent return?
Problem 3.

Good Luck!