Reading 31 Overview of Types of Real Estate Investment - Answers

Question #1 of 15 Question ID: 1686896 Which of the following is most likely to represent a publicly traded real estate debt investment? A) A mortgage real estate investment trust (Mortgage REIT). B) A real estate operating company (REOC). C) Secured bank debt collateralized by real estate. Explanation Mortgage REITs are publicly traded securities that make loans secured by real estate, therefore they are publicly traded debt investments. REOCs are classified as equity (not debt) securities, while bank debt is classified as a private rather than public investment. (Module 31.1, LOS 31.a) Question #2 of 15 Question ID: 1686907 A real estate market is characterized by frequent transactions. However, individual properties have long holding periods. Which real estate pricing index would be least suitable in such an environment? A) Repeat sales index. B) Hedonic price index. C) Appraisal based index. Explanation Repeat sales index relies on repeat sales of individual properties. Since individual properties have long holding periods, repeat sales index would be least suitable. Hedonic price index relies on transaction data and the regression model explains the variation in transaction prices based on differences between individual properties sold. Appraisal based indices use transaction prices also to estimate value after adjustments for differences. Since there are plenty of transactions, appraisal and hedonic price index have sufficient data to provide good value estimates. (Module 31.3, LOS 31.e) Question #3 of 15 Question ID: 1686895 Which of the following least accurately identifies a type of publicly traded real estate security? A) Operating companies. B) Direct mortgage lending. C) Investment trusts. Explanation The main types of publicly traded real estate securities are REITs (real estate investment trusts), REOCs (real estate operating companies), and RMBS and CMBS (residential and commercial mortgage-backed securities). Direct mortgage lending is most likely to be a private rather than public investment. (Module 31.1, LOS 31.a) Question #4 of 15 Question ID: 1710723 An increase in goods and services production is most likely to be a top economic factor affecting the economic value of a(n): A) industrial REIT. B) health care REIT. C) residential REIT. Explanation An increase in goods and services production usually leads to greater demand for office, industrial, and retail space among businesses. (Module 31.2, LOS 31.b) Question #5 of 15 Question ID: 1686897 Which of the following most accurately identifies non-core real estate property types? A) Retail and multi-family residential. B) Office and industrial. C) Hotel and hospitality. Explanation Hospitality properties such as hotels represent relatively risky investments because these properties do not use long-term leases and their performance may be highly correlated with the business cycle. The core commercial income-producing real estate property types are retail, multi-family, office, industrial and warehouse. These "core" property types are the main properties used to create a low-risk real estate portfolio. (Module 31.1, LOS 31.a) Question #6 of 15 Question ID: 1710722 Which of the following is least likely a difference between real estate investments and traditional asset classes like stocks and bonds? A) Real estate tends to be difficult to value B) Real estate tends to be homogenous C) Real estate tends to be indivisible Explanation Investment in real estate is complicated by difficulty in valuing real estate, indivisibility of real estate investment (high unit value) and heterogeneity of different real estate properties even within the same class/geographical location. (Module 31.2, LOS 31.b) Question #7 of 15 Question ID: 1686894 Which of the following most accurately identifies a private equity investment in incomeproducing real estate? A) Investment in a real estate investment trust (REIT). B) Direct ownership of real estate properties. C) Private market mortgage lending by an insurance company. Explanation Real estate investments take four major forms: private equity, publicly traded equity, private debt, and publicly traded debt. Private equity investment in real estate refers to direct ownership of real estate properties. Mortgage lending by banks or insurance companies is best described as private debt. Indirect ownership of real estate through equity securities such as REITs is an example of publicly traded equity. (Module 31.1, LOS 31.a) Question #8 - 11 of 15 Question ID: 1686902 Based on projected real estate conditions and the partners' discussion given in the vignette, 3CC's top recommendation would most likely be: A) public debt. B) private equity. C) public equity. Explanation The category that 3CC would most likely recommend as first choice is private equity option. Chekov prefers equity to debt option and Chanwit prefers private over public option. Clarkson wants to eliminate private debt option. Their statements are also consistent with the real estate market expectations. (Module 31.1, LOS 31.a) Question #9 - 11 of 15 Question ID: 1686903 If the pension plan chooses to invest in mortgage REITS, the most likely benefit from the investment is the: A) inflation hedge. B) current income. C) capital appreciation. Explanation The most likely benefit of a pension plan buying mortgage REITs is current income. Mortgage REITs are required by law to distribute a high percentage (often 90%) of their taxable income to shareholders in the form of dividends. This would provide a steady stream of income for the pension plan, which needs to generate income to pay out benefits to retirees. While mortgage REITs can offer some capital appreciation and may act as a mild inflation hedge, current income is the primary benefit they provide for pension plans. (Module 31.2, LOS 31.b) Question #10 - 11 of 15 Question ID: 1686904 If the pension fund chooses to invest in hotels over apartments, one possible reason for this is that hotels: A) may offer higher rates of returns because they are more management intensive. B) are commercial properties while apartments are residential properties. C) are not affected by cost and availability of debt capital. Explanation All real estate values are affected by cost and availability of capital. Apartments and other multi-family units are considered commercial real estate. Hotels require more active management making them more risky ventures as more operational expertise is needed. This additional risk requires a higher rate of return. (Module 31.2, LOS 31.c) Question #11 - 11 of 15 Which statement regarding issues with indices is least likely correct? A) Chanwit’s statement. B) Clarkson’s statement. C) Chekov’s statement. Explanation Question ID: 1686905 Clarkson's concerns about Lincoln Hedonic Index if individual properties don't sell more than once are unfounded. Hedonic Index construction does not require multiple sales of the same property. (Module 31.3, LOS 31.e) Question #12 of 15 Question ID: 1686900 Which of the following least accurately describes a major element of real estate due diligence that should be conducted in evaluating a property? A) Pipeline analysis. B) Future lease outlook. C) Market review and outlook. Explanation The major elements of real estate due diligence include: financial review, current lease review, future lease outlook, market review and outlook, property inspection and service agreements, and documentation review. (Module 31.3, LOS 31.d) Question #13 of 15 Question ID: 1686899 Appropriate due diligence in a private real estate investment is most likely to: A) mitigate unforeseen potential problems. B) expedite the closing process. C) lower existing operating costs. Explanation Due diligence can be very costly but it can potentially lower risk of unexpected legal and physical estate problems. Due diligence can be a lengthy process, involving reports, inspections, and professional consultations. This can delay the closing process and add up in costs associated with appraisers, inspectors, lawyers, etc. (Module 31.3, LOS 31.d) Question #14 of 15 Question ID: 1686906 Compared to transaction-based indices used to track the performance of private real estate, appraisal-based indices are most likely to exhibit an apparent: A) higher volatility. B) time lag. C) higher correlation with other asset classes. Explanation Appraisal-based indices tend to lag transaction-based indices, as appraised values adjust only slowly to sudden shifts in the market. Appraisal-based indices are "smoothed" by this lag, which causes appraisal-based indices to appear to have lower volatility and lower correlation with other assets than a transactionbased index would. (Module 31.3, LOS 31.e) Question #15 of 15 Question ID: 1710724 Which of the following most accurately identifies one of the characteristics of a private equity investment in income-producing real estate? A) Passive management. B) Sensitivity to the credit market. C) Homogeneity. Explanation Real estate values are sensitive to the cost and availability of debt capital since large amounts of borrowing are required to purchase real estate properties. Real estate is heterogeneous, as no two properties are the same. Direct ownership of real estate properties is management intensive. Other unique characteristics possessed by real estate properties include: fixed location, high unit value, depreciation, high transaction cost, illiquidity, and difficult to value. (Module 31.2, LOS 31.c)