ANSWERS TO CHAPTER QUESTIONS
Chapter 9 Real Estate and Other Assets
1) Homes have a combination of three factors in purchasing:
a) Shelter
b) Leisure as a relaxing place which also allows individual expression in decorating.
c) Investment – well maintained homes appreciate over time.
2) Well taken care of homes in good neighborhoods tend to grow at a rate modestly
3) Characteristics of a mortgage include:
a) Principal – total amount borrowed
4) Purchase of a home is better than renting because:
a) It provides a tax deduction for mortgage interest and real estate taxes.
b) It provides a tax deferral on gains until sale.
c) There is no taxation on the first $250,000 of gains when one individual owns it
and $500,000 if two or more people own it.
Renting is more attractive than buying when:
a) You expect a decline in the price of a home.
5) A home is a good inflation hedge because:
a) It historically has been positively correlated with inflation when inflation moves
up sharply.
b) Fundamentally, the cost of new homes rise when inflationary-induced increases in
labor and materials up. Sales prices generally have to follow the boost, although a
A home is still an asset even if there is no expectation of sale because:
a) A reverse mortgage can be obtained for funds that will allow one to stay in the
home for the rest of one’s life.
6) One of the main differences in home ownership versus REITs is the level of
ownership. REITs can be publicly privately owned investment companies whereas a
7) Direct ownership can be preferable when a greater degree of control is wanted over
the property. In addition direct ownership is much more liquid than a private
partnership as there does not need to be a formal discussion and agreement in order to
proceed. Direct ownership may be an attractive option to a doctor with a private
practice as it can provide substantial upside.
8) The comparable sales method of valuing real estate would be preferred. The
9) The cap rate is determined by the following formula: Cap rate = Net operating income
(EBITDA)/ building value.
10) The cap rate can be thought of as the cash yield based on the property’s purchase
price.
12) Investing in gold is appealing as it is negatively correlated with the performance of
13) Investors should treat commodities as hedges against inflation, however commodities
should not be looked at or treated the same as traditional investments. Commodities
are not meant to be used as long-term growth investments.
ANSWERS TO CHAPTER PROBLEMS
Chapter 9 Real Estate and Other Assets
1. Jack’s original purchase price of $90,000 + $15,000 of renovation gets added to the
basis. Jack sells at $400,000 giving him a $295,000 gain. $250,000 of that gain is tax free
2. Recall the return on house for the period
3. Josh must not exceed 28% of his income. 80,000*0.28 = 22,400
22,400 is his allowable housing expense.
4. Recall the formula for cap rate is = net operating income (EBITDA)/ building value
ANSWERS TO CASE APPLICATION QUESTIONS
Chapter 9 Real Estate and Other Assets
1)
Increase in House
Value During Period
Rent Not Paid
Cost of Upkeep
2)
Nonfinancial Investments – A Partial Balance Sheet1
Assets
Liabilities
1Assumes both proposed investments, the furnace and the home, were bought and 80% of
the home’s purchase price was financed through debt.
2Placeholder figure, actual household equity is unknown since this is a partial balance
sheet.