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Chapter 25/27—Investing in Real Estate
MULTIPLE CHOICE
1. You are offered a four-unit residential building in which each unit rents for $500 per month. Given a 5
percent vacancy rate, operating expenses of $700 per month, and mortgage payments of $1,500 per
month, you can anticipate a monthly
a.
net spendable income of $200.
b.
net spendable income of $300.
c.
negative cash flow of $200.
d.
negative cash flow of $300.
2. To be considered a good investment, when a property which generates a negative cash flow is sold,
a.
there must be a substantial increase in property value.
b.
there need be little increase in property value.
c.
the investor is best off if the property has decreased in value.
d.
there must be a substantial down payment.
3. Which of the following is necessary in order to calculate cash flow?
a.
Monthly appreciation
b.
Mortgage balance
c.
Monthly rents
d.
Economic rents
4. A rental property produces $2,000 per month in rents and consumes $600 per month in operating
expenses. The mortgage payment is $1,200 per month. For the investor, this property produces a
a.
positive cash flow.
b.
zero cash flow.
c.
negative flow.
d.
break even cash flow.
5. If vacancies and collection losses, property taxes, expenses of operation and loan service are deducted
from the gross income, you have
a.
internal rate of return.
b.
taxable income.
c.
net spendable income.
d.
net worth.
6. If a potential investment is referred to as an alligator or loss, the investor knows he can expect
a.
water problems.
b.
a negative cash flow.
c.
no profit.
d.
a break even investment
7. When one holds unimproved land as an investment, expenses such as taxes and interest are
a.
not deductible for income tax purposes.
b.
deductible in the year in which the expenses are incurred.
c.
deductible the following year.
d.
deductible only when the property is sold.
8. A woman owns an $86,000 house on which she pays $329 per month interest. If she is in a 28% tax
bracket, how much less tax will she have to pay per year because she owns it?
a.
$131.60
b.
$653.49
c.
$1,105.44
d.
$2,763.60
9. Weldon bought a duplex and lives in one half. On his tax report, he can deduct
a.
all expenses on only the half he lives in.
b.
all expenses on the rented half.
c.
all expenses on both halves.
d.
no expenses because it is his residence.
10. Roberto has been depreciating a piece of residential income property for 17 years. He then sells it to
Pauline. How many more years can Pauline depreciate the property?
a.
10 1/2 years
b.
17 years
c.
Up to 27 1/2 years
d.
It depends on cash flow and Pauline’s tax rate
11. Which of the following real property investments is most likely to produce the largest annual
depreciation allowance expressed as a percentage of owner’s equity? Assume each is newly purchased
for 100% cash.
a.
Large tract of land
b.
Old apartment building
c.
Retail business in rented space
d.
New business
12. An investment property was purchased in 2008 for $180,000. The land accounted for 30% of this
value. If figured on a 30-year life, what was the book value of this property after one year of straight-
line depreciation?
a.
$54,000
b.
$121,800
c.
$126,000
d.
$175,800
13. The type of depreciation in which a fixed yearly sum is subtracted from the depreciable value of the
property is called
a.
sum of the years digits.
b.
straight-line.
c.
double declining balance.
d.
accelerated.
14. An owner is using straight-line depreciation over a 27 1/2 year period on a $65,000 rental unit. If the
improvements are worth $55,000, what is the depreciation in the first year?
a.
$2,000.00
b.
$2,181.81
c.
$2,363.63
d.
$4,363.63
15. Two investors buy a house for use as a rental property. Their accountant tells them they can deduct
depreciation on 80% of the $76,000 value over 27 1/2 years. How much can they deduct in the third
year of ownership?
a.
$2,211
b.
$4,422
c.
$6,633
d.
$6,756
16. A real estate agent buys a house and lot for $49,900. He spends $1,200 to remodel it. What price
must he sell the property for to realize a 20% profit?
a.
$61,320
b.
$58,440
c.
$59,880
d.
$42,583
17. A property is purchased for $50,000 with a $45,000 loan. Several years later the loan has been
reduced to $40,000 and the property is sold for $55,000. What is the seller’s equity build-up at the
time of sale?
a.
none
b.
$5,000
c.
$10,000
d.
$15,000
18. An investor is using borrowed money to increase the rate of return on a cash investment in an income
property. He is
a.
using leverage.
b.
using a trust deed.
c.
kiting.
d.
insolvent.
19. When the benefits of borrowing money for investing exceeds the costs of borrowing, you have
a.
negative leverage.
b.
positive leverage.
c.
usury.
d.
capitalization rate.
20. If an investor uses $250,000 of his own money when buying a $500,000 building, he is using
a.
50% leverage.
b.
100% leverage.
c.
200% leverage.
d.
capital gains.
21. If an investor is seeking the greatest risk and the greatest return, when should he buy?
a.
Before construction
b.
During construction
c.
After construction
d.
Upon occupancy by anchor tenants
22. Which of the following age groups should be the most cautious in terms of investment risk taking?
a.
35-45 years
b.
45-55 years
c.
55-65 years
d.
65+ years
23. One of the main advantages of being a limited partner is
a.
the profits of a limited partner are tax free.
b.
limited partners can help with management.
c.
limited partners are not held responsible for management.
d.
limited partners are separate legal persons.
24. In a general partnership
a.
each partner has limited financial liability.
b.
each partner pays individual taxes on his or her share of the partnership’s earnings.
c.
the right of survivorship exists.
d.
individual shares are not taxed.
25. The limited partnership has become popular as a means of owning real estate because of
a.
limited ability to finance large properties.
b.
maximum management responsibility.
c.
direct pass-through of profits.
d.
unlimited liability.
26. A four unit quadruplex has rental income of $500 per month per unit. Given a 5% vacancy rate,
operating expenses of $700 per month, and mortgage payments of $1,500 per month, you can
anticipate a monthly
a.
net spendable of $200.
b.
net spendable of $300.
c.
negative cash flow of $200.
d.
negative cash flow of $300.
27. Monetary benefits of investing in real estate come from
a.
cash flow.
b.
tax shelter.
c.
mortgage reduction.
d.
all of the above.
28. A negative cash flow may be offset by
a.
tax shelter.
b.
appreciation.
c.
both a and b.
d.
neither a nor b.
29. Mortgage balance reduction is
a.
an out-of-pocket expense.
b.
a deduction for tax purposes.
c.
tax-exempted.
d.
quite large at the beginning of the loan period.
30. The value of depreciation on an investment property is
a.
inversely proportional to the investor’s tax bracket.
b.
the same to all investors, regardless of their tax bracket.
c.
directly proportional to the investor’s tax bracket.
d.
not a factor in the investment decision.
TRUE/FALSE
1. Considering an apartment building, a retail business in a leased space, a housing subdivision selling
finished homes or an unimproved tract of land, the apartment building is most likely to result in a
negative cash flow.
2. When an investor speaks of an investment that will pencil out, she means there will be more book
work involved than the investment justifies.
3. An owner-occupied residence cannot be depreciated for federal income tax purposes.
4. A United States taxpayer can, on his income tax report, deduct depreciation on a tenant occupied
suburban home.
5. Accelerated depreciation schedules, set up before the Tax Reform Act of 1986 became effective, were
grand fathered in and did not change.
6. If an investor wanted to put leverage to its best advantage, he would purchase property by investing all
of his own cash and borrowing as little as he can.
7. As a rule of thumb, for the investor to break even, the value of raw land must double every 10 years.
8. An individual investor who is seeking the advantages of a partnership, but who wishes to avoid
unlimited financial liability would join a limited partnership.
9. Tax laws will not allow depreciation on a building to be started over each time the property is sold.
10. Equity buildup in a property can be the result of mortgage reduction and appreciation.
11. Negative leverage occurs when an investment property depreciates in value.
12. The cash-on-cash ratio for a property that has a cash flow of $16,900 and could be purchased with a
down payment of $130,000 would be 7.69%.
13. To be considered a good investment, when a property that has a negative cash flow is sold there must
be a substantial increase in property value.
14. Tax shelter in real estate is not available for rent houses.
15. For most people, the best time to invest in high-risk investments is between the ages of 55 and 65.
16. In a typical limited partnership, the organizers are the limited partners.
17. In a limited partnership, the limited partners cannot lose more than the amount they have invested.
18. A disclosure statement given prospective investors in a limited partnership, outlining the plan and
prospects for the partnership as called a cash flow projection.
19. The impact that borrowed funds have on investment return is known as leverage.
20. Equity build-up can result from appreciation as well as debt reduction.
COMPLETION
1. The income tax savings that an investment can produce for its owner is called a tax
____________________.
2. ____________________ is the increase in property value that the owner hopes will occur while
owning it.
3. If an investor has to dip into cash reserves to keep a property going, the property has a
____________________ cash flow.
4. In contrast to straight-line depreciation, ____________________ depreciation is any method that
allows depreciation at a rate faster than straight-line.
5. In an effort to encourage individuals to rebuild older structure, Congress has had a policy of giving
____________________ tax credits.
6. In the various phases in the life cycle of improved real estate investments, ____________________
come between tenancy stage and the maturity stage.
7. In a typical limited partnership, the organizers are ____________________ partners.
8. To insure that information on the soundness of an investment is passed on the prospective investors,
several states have enacted ____________________ laws.
9. A limited partnership wherein properties are purchased after the limited partners have invested their
money is called a ____________________ pool partnership.
10. In a partnership, the risk of losing one’s money is referred to as a ____________________ risk.
MATCHING
Choose the one most appropriate answer for each.
a.
accelerated depreciation
k.
investment strategy
b.
active investor
l.
leverage
c.
appreciation
m.
master limited partnership
d.
at-risk rules
n.
negative cash flow
e.
blind pool
o.
negative leverage
f.
cash flow
p.
non-recourse financing
g.
cash-on-cash
q.
passive investor
h.
downside risk
r.
prospectus
i.
equity build-up
s.
straight-line depreciation
j.
GLITAMAD
t.
tax shelter
1. number of dollars remaining each year after collecting rents and paying operating expenses and
mortgage payments
2. requires the investor to dip into her own pocket
3. income tax savings that an investor can produce for its owner
4. results from mortgage reduction and price appreciation
5. an acronym that refers to the various phases of the life cycle of improved property
6. a method of calculating depreciation that takes equal amounts of depreciation each year
7. any method of depreciation that achieves a faster rate of depreciation than the straight-line method
8. a limited partnership wherein properties are purchased after the limited partners have invested their
money
9. the possibility that an investor will lose his money in an investment
10. a disclosure statement that describes an investment opportunity
11. the cash flow of a property divided by the amount of cash needed to purchase it
12. as defined by tax law, the amount an investor risks in an investment
13. the impact that borrowed funds have on investment return
14. an investor who takes an active role in property management, as defined by income tax law
15. limited partnership that can be traded on a stock exchange nearly as easily as corporate stock
16. financing where the borrower is not personally liable
17. a limited partner who does not materially participate on a “regular, substantial, and continuous basis”
18. if the borrowed funds cost more than the benefits they are producing
19. increase in property value that the owner hopes will occur while owning it
20. a plan to balance the returns available with the risks that must be taken to achieve those returns
