CHAPTER 17
Sources of Commercial Debt and Equity Capital
Test Problems
1. Double taxation of the income produced by the underlying real estate is most
likely to occur if the commercial properties are held in the form of a(n):
2. With regard to double taxation, distributions, and the treatment of the losses,
general partnerships are most like:
3. Special allocations of income or loss are available if the form of ownership is
a(n):
4. Small to medium size real estate syndicates that develop or acquire property in a
local market are most typically organized most frequently as:
5. A real estate investment trust generally:
6. Which of the following forms of ownership involve both limited and unlimited
liability?
7. Which statement is false concerning the limited partnership form of ownership?
c. The limited partners cannot enjoy tax deduction benefits but the general
8. Which of these lenders is most likely to provide a construction loan?
9. Which of these loans is a life insurance company most likely to invest in?
10. Which of these financial firms is the least likely to invest in a large, long-term
mortgage loan on a shopping center?
Study Questions
1. For what debt in a general partnership is each of the general partners liable?
Solution: General partners have unlimited liability and are liable for all debts of the
partnership. This includes contractual debts and debts resulting from tort actions against
2. What are the potential advantages of investing in commercial real estate through
intermediaries instead of direct investment? What are the potential disadvantages?
Solution: Investing through intermediaries avoids some of the cons of direct investment
because the required expertise (including better information) is supplied by the sponsor of
the intermediary. Investing through intermediaries may also provide more liquidity and
3. Discuss the role life insurance companies play in financing commercial real estate.
Solution: Given the long-term nature of their liabilities, life insurance companies prefer to
4. Approximately 88 percent of private commercial real estate equity (on a value-
weighted basis) is owned by “noninstitutional” investors. Who are these investors?
Solution: These “noninstitutional” investors include both individual investors and groups
of private investors who pool their capital via several types of ownership structures,
5. Briefly explain a commingled real estate fund. Who are the investors in these funds
and why do these investors use commingled funds for their purchases?
Solution: A commingled fund is a means for pension funds that do not possess sufficient
in-house real estate expertise to invest in real estate. Pension funds contribute funds to a
6. There are two primary considerations that affect the ownership form selected by
equity investors to hold commercial real estate. List each and explain how they affect the
choice of ownership form.
Solution: Federal income taxation rules, and the avoidance of personal liability for debts
Federal income taxation is a critical factor in the determination of which ownership form
to use in real estate investment. The income produced by properties owned by C
Investors prefer ownership structures that provide limited liability. C corporations, S
corporations, limited partnerships, and limited liability companies shield investors from
7. Explain what is meant by the double taxation of income.
Solution: Double taxation refers to the taxation of income at both the entity and investor
level. For example, a C corporation pays tax on its income, which reduces the amount
8. What are the major restrictions that a REIT must meet on an ongoing basis in order to
avoid taxation at the entity level?
Solution: A REIT must have at least 100 shareholders and 50 percent or more of the
REIT’s shares cannot be owned by five or fewer investors. A REIT is required to
9. Compare the tax advantages and disadvantages of holding income-producing property
in the form of a REIT to the tax advantaged and disadvantages of holding property in the
form of a real estate limited partnership. Does either form dominate from a tax
perspective?
Solution:
A REIT is a C corporation and but, unlike the standard C corporation, does not pay
income tax at the entity level if it adheres to a set of conditions outlined in the Internal
Real estate limited partnerships are not subject to double taxation because income tax is
not assessed at the entity level. Limited partnerships may allocate tax losses to partners,
In practice and from a tax perspective, pass through entities such as limited partnerships
and limited liability companies are the dominant form of ownership structures used to
10. Of the more than $3.2 trillion in outstanding commercial real estate debt, what
percent is traded in public markets? What percent is traded in private markets? What
institutions or entities are the long-term holders of private commercial real estate debt?
Solution: Approximately 24 percent of commercial real estate debt is traded in public
markets and the remaining 74 percent is privately held by institutional and individual
11. Distinguish between equity REITs and mortgage REITs.
Solution: Equity REITs invest in and operate commercial properties. Mortgage REITs
purchase mortgage obligations (typically commercial) and thus become, effectively, real
estate lenders.
12. Define funds from operations (FFO) and explain why this measure is often used
instead of GAAP net income to quantify the income-producing ability of a real estate
investment trust.
Solution: GAAP accounting includes non-cash deductions, such as deprecation and
amortization of certain financial and fixed assets. Therefore, if a REIT has significant
amortization expenses to GAP income. Additionally, FFO adjusts GAAP income for
gains and losses from infrequent and unusual events. Formally, FFO is defined as:
FFO = Net income (GAAP)
+ Depreciation (real property)
13. How have equity REITs, measured in terms of total returns, performed in recent
years relative to alternative stock investments?
Solution: As a sector, equity REITs produced an average annual return of 22.9 percent
from 2000-2006. The corresponding average return on the S&P 500 and Russell 2000
were 2.5 percent and 9.6 percent, respectively. In 2007 and 2008, however, equity REITs