Real Estate Finance & Investments, 16e (Brueggeman)
Chapter 12 Financial Leverage and Financing Alternatives
1) Financial leverage is defined as benefits that may result to an investor by borrowing money at
a rate of interest that is lower than the expected rate of return on total funds invested in a
property.
2) To determine whether leverage is positive or negative, the investor needs to determine
whether the IRR is greater than the market rate of interest on mortgage loans.
3) One benefit of leverage is that it reduces the variation in returns or losses.
4) One benefit of leverage is that it may allow an investor to diversify across several investment
properties.
5) One advantage of a sale-leaseback is that the lease payments are 100 percent tax deductible.
6) One advantage of using leverage is that NOI increases with higher amounts of leverage.
7) When the internal rate of return on an investment increases as the loan-to-value ratio
increases, positive leverage exists.
8) If a property has positive leverage, the owner should borrow as much as possible.
9) In an inflationary environment where property values are also rising, a participation loan may
provide a lender with some protection against unanticipated inflation.
10) An interest-only loan will provide a higher debt coverage ratio than an amortizing loan with
the same interest rate.
11) Everything else equal, the loan balance on a negative amortization loan will be less than that
on an interest-only loan after the first year.
12) When constructing a convertible mortgage, the lender will require a contract interest rate
equal to or greater than the market rate on a similar mortgage without a conversion option.
13) The loan alternative with the highest ATIRR will always be preferable to the borrower.
14) Properties with a higher ratio of debt are considered to also have a higher risk assuming
everything else is equal.
15) If a property owner borrows money at a rate that is higher than the equity yield rate, negative
leverage exists.
16) A loan in which the lender receives part of the proceeds from the sale of the property is
known as a convertible loan.
17) A decrease in financial leverage would be expected to magnify the risk and the potential
return of an income-producing property.
18) An investment has the following characteristics:
ATIRRP: After-tax IRR on total investment in the property: 9.0%
BTIRRE: Before-tax IRR on equity invested: 17%
BTIRRP: Before-tax IRR on total investment in the property: 12%
t: Marginal tax rate: 0.40
What would be the break-even interest rate (BEIR), at which the use of leverage is neither
favorable nor unfavorable?
A) 15.0%
B) 20.0%
C) 22.5%
D) 28.3%
19) Under which conditions would one be MOST LIKELY to see an interest rate swap?
A) A borrower wants a fixed rate loan, but the bank only offers floating rate loans; the borrower
“swaps” loans with someone who has a fixed rate loan
B) A borrower does not have enough equity for a conforming loan, so he or she takes out a
“second” mortgage loan
C) A borrower does not have enough equity for a conforming loan, so he or she “swaps”
mortgage insurance for increased equity investment
D) A bankruptcy court orders a lender to “swap” a debtor’s high interest rate for a lower interest
rate
20) A lender requires a 1.20 debt coverage ratio as a minimum. If the net operating income of a
property is $60,000, what is the maximum amount of debt service the lender would allow?
A) $30,000
B) $50,000
C) $60,000
D) $72,000
21) All other things being equal, which of the following best describes the effects of leverage on
an investment’s risk-return characteristics (assuming the expected return is greater than the
lending rate)?
A) Lower expected return, lower risk
B) Lower expected return, higher risk
C) Higher average return, higher risk
D) Higher average return, lower risk
E) Risk-return characteristics have no role in investment decision making
22) A property is financed with a 75% loan at 11.5% over 25 years. The property produces an
ATIRR on total investment of 7.34% based on a tax rate of 31%. What can be said about the
leverage associated with the property?
A) Negative leverage exists
B) Positive leverage exits
C) No leverage exists
D) Can’t tell without knowing the ATIRR on equity
23) A property produces an 8.92% ATIRR on the total investment considering a tax rate of 28%.
What is the maximum interest rate that could be paid on debt without causing the leverage to be
negative?
A) 12.39%
B) 11.42%
C) 6.42%
D) 9.37%
24) A loan in which the lender receives a percentage of the net operating income from the
property is known as a(n):
A) Participation loan
B) Accrual loan
C) Convertible loan
D) Percentage loan
25) A loan in which the lender has an option to purchase an equity interest in a property is
known as a(n):
A) Participation loan
B) Accrual loan
C) Convertible loan
D) Percentage loan
26) Which of the following would NOT be considered an advantage that an investor might
consider under a sale-leaseback of land?
A) The sale-leaseback in effect provides 100% financing on the land
B) Lease payments are tax deductible
C) The sale-leaseback provides the same depreciation deductibility with a smaller equity
investment
D) The land may appreciate over the holding period
27) Which of the following is also referred to as a negative amortization loan?
A) Participation loan
B) Accrual loan
C) Convertible loan
D) Interest only loan
28) A lender requires a 1.20 debt coverage ratio as a minimum. If the net operating income of a
property is $45,000, what annual amount of debt service would provide the required debt
coverage ratio?
A) $37,500 or higher
B) $37,500 or lower
C) $54,000 or higher
D) $54,000 or lower
29) If properly constructed, and assuming everything but the structure of the interest payment is
equal, which of the following loans would typically have the highest first-year debt service?
A) Accrual loan
B) Conventional loan
C) Interest only loan
D) Participation loan
30) A property is financed with an 85% loan–to-value ratio at 10% interest over 25 years. What
would the BTIRRE on equity be estimated at, given that the BTIRRp is 10.75%?
A) 10.1%
B) 10.4%
C) 15.0%
D) 13.2%
31) Which of the following typically would NOT be used as a basis for a participation loan?
A) Increase in value over the holding period
B) NOI in excess of a base amount
C) Cash Flow after regular debt service
D) Potential gross income
32) Which of the following is NOT a benefit of a sale-leaseback of land for investors?
A) It is a way of effectively obtaining 100% financing
B) The lease payments are tax deductible
C) Land cannot be depreciated for tax purposes
D) The land value may increase over the holding period
33) Which of the following is FALSE regarding interest only loans?
A) They usually have balloon payments
B) They have greater amortization than conventional loans
C) They may result in more cash flow to the investor
D) They may allow for a lower DCR
34) Which of the following gives the lender an option to purchase a full or partial interest in the
property at the end of some specified period of time?
A) Convertible loan
B) Sale-leaseback
C) Accrual loan
D) Interest only loan
35) Which of the following is FALSE regarding negative amortization?
A) It can result in a decrease to the borrower’s equity in the property
B) It usually increases default risk
C) It usually has a lower interest rate than a conventional loan
D) It usually results in a lower DCR
36) Lenders for income-producing properties refer to loans that are short term and require little
or no amortization as:
A) Missile loans
B) Straight loans
C) ARM loans
D) Bullet loans
37) The maximum interest rate that could be paid on a debt before the leverage becomes
unfavorable is referred to as the:
A) Incremental cost of debt
B) Break-even interest rate
C) Favorable interest rate
D) Optimistic interest rate