RECA COMMERCIAL UNIT2 EXAM
QUESTIONS WITH CORRECT
DETAILED ANSWERS
Operating expenses - Answer- Costs a landlord incurs through the operation of a real
estate asset (e.g. property taxes, insurance, maintenance and repairs, management,
utilities, and common area maintenance).
Option (6 examples) - Answer- A clause in a lease that gives the tenant an exclusive
right. It usually includes a period of time during which the option must be exercised.
There are many types of options that can be included in lease agreements, such as:
Renewal Option: Gives the tenant the right to renew their initial lease term upon
expiration of the lease
Expansion Option: Gives the tenant the right to request additional space as their
business needs change
Relocation Option: Grants the landlord the right to provide similar space when they
require the subject space to accommodate another tenant
Right of First Refusal Option: Gives the tenant the right of first refusal to purchase the
real estate asset for a specified price during a specific time frame
Termination Option: Gives the tenant the right to terminate the lease in whole or in part
under pre-negotiated terms. The terms often require the tenant to pay all unamortized
inducements the landlord made when the lease was negotiated, such as tenant
improvements and rent abatement. In addition, the tenant may be required to repay any
unamortized portion of the real estate commissions that were paid.
Re-measurement Option: Gives the landlord the right to re-measure the tenant's leased
space or the entire building and confirm or correct the measurements in accordance
with the measurement standards defined in the lease.
Potential gross income (PGI) - Answer- The maximum income a real estate asset is
capable of producing.
Pro forma statement - Answer- A set of financial projections or forecasts for a real
estate asset that are used to estimate either the value of the asset or a potential return
from purchasing the asset at a certain price.
,Rent abatement - Answer- A period of time where the landlord chooses to forgive some
or all of the basic rent, additional rent, and/or parking rent.
Risk - Answer- The degree of chance an investment will result in a financial loss. It is a
function of the volatility of the expected return.
Vacancy and collection allowance - Answer- An estimate of the amount by which
potential gross income (PGI) should be reduced to account for vacancies (i.e. lease
space that does not generate income) and collection losses (i.e. non-payment of rent).
Performing an unleveraged DCF analysis involves the following three steps: - Answer- 1
Forecasting the expected future net cash flows
2 Determining the discount rate
3 Valuing the investment
A lease abstract - Answer- A lease abstract is a document outlining the key economic
and legal elements of a lease, including a description of the premises, the names of the
parties to the agreement and their primary addresses, net rents and other items of value
(e.g. tenant improvements, escalations), the lease term, and the key covenants and
conditions with references to the relevant page, clause, or exhibits in the lease
agreement. Although there is no substitute for a careful review of each lease
agreement, the rent roll and lease abstracts should provide the key data needed to
prepare a pro forma statement.
rent roll - Answer- The rent roll is a document listing all of the tenants leasing space in a
real estate asset along with the key elements of their respective leases, including the
rent amounts, the date and amounts for future escalations, the start date of the lease,
and the lease term. It also typically lists all income generated by the real estate asset,
such as parking, signage, and storage.
True or false - In addition to carefully reviewing the lease agreements, real estate
professionals representing buyers in commercial real estate trades should ensure they
request the seller provide an Estoppel Certificate for each tenant. - Answer- True - An
Estoppel Certificate confirms the current details of the lease and financial status of the
tenant as of the date on the certificate. Although the form and content of an Estoppel
Certificate is dictated in the lease agreement, it will typically include the following
information:
The commencement and expiration dates of the original lease and extensions or
renewals that have occurred
The basic rent amount
The area of the premises
Any financial or other obligations that remain on behalf of the current landlord to the
tenant (e.g. TI allowance, rent abatement)
The payments (e.g. rent, additional rent) that the tenant has made
,Any pending or current litigation between the tenant and the current landlord
The seller, their real estate professional, or their legal expert typically completes the
Estoppel Certificate as prescribed in the lease agreement and then has the tenant sign
it. Upon receiving the Estoppel Certificate(s), the buyer's real estate professional should
provide them to their client for review.
An operating budget - Answer- An operating budget consists of all revenues and
expenses over a period of time (typically a quarter or a year) and is used to plan an
asset's operations. An operating budget is prepared in advance as a goal the asset is
expected to achieve. Financial statements are a formal record of the current financial
activities and condition of an asset. They are useful for determining the ability of the
asset to generate income and the sources and uses of that income.
Market Analysis - Answer- A market analysis is a study of the supply of and demand for
a real estate asset and/or its space in a geographically-defined area to determine
attributes of products in the market as well as current or expected prices or rents. Often
the analysis includes an investigation of how a particular real estate asset could be
absorbed, sold, or leased under current or anticipated market conditions. It also
identifies trends and events that could have implications for the asset's value.
The following elements are essential for a pro forma statement for the purposes of an
Unleveraged DCF analysis: (x4) - Answer- Initial investment: The initial investment is
the purchase price of the real estate asset plus any costs incurred to acquire it, such as
due diligence and legal costs. Due diligence costs may include fees for environmental
site assessments, building condition assessments, and appraisals, as well as
commissions for the real estate professionals facilitating the transaction. In other words,
the initial investment is the total monetary outlay required to obtain the real estate asset.
Reversionary value: Reversionary value is the estimated value of the asset at the end of
the holding period when disposition occurs. In other words, it is the expected sale price
for the asset, less disposition costs such as legal costs and commissions for the real
estate professionals facilitating the transaction. In other words, it is the total monetary
outlay required to sell the real estate asset.
Holding period
Annual cash flows
An escalation rate - Answer- An escalation rate is a pre-specified increase in the rent or
operating expenses during the term of the lease. The market usually determines the
rate of escalation allowed. The escalation rate is typically based on the following:
Annual Consumer Price Index (CPI) or other index for rent or operating expenses
Flat with escalations of specified amounts at future dates for rent
, Flat with escalations to market rates at future dates for rent
Market Discount Rate - Answer- The market discount rate is a measure of investment
performance over a holding period that accounts for risk and return on capital.
Therefore, the market discount rate is the sum of the following three components:
Discount rate = Risk Free Rate of return + Risk Premium + Constant Growth rate
The risk free rate of return - Answer- The risk free rate of return is what you would
expect from an investment that has no risk of default. Government backed securities are
generally believed to be risk free. Assuming the typical holding period of a real estate
asset is five years, the risk free rate of return can be based on the return for a five-year
Government of Canada treasury bond as it is risk-free investment.
the real rate - Answer- The real rate consists of what remains of the return after
accounting for inflation.
Gordon Growth Model (GGM) - Answer- The GGM, sometimes called the dividend
growth model or growing perpetuity model, is traditionally used in finance to value
stocks with dividend growth. Real estate assets tend to have annual income that grows
fairly steadily over time, much like the dividend of a mature company, so the GGM can
also be applied in this situation.
Formula for the Gordon Growth Model - Answer- Value = Dividend / r-g
Dividend = Cashflow
r = Discount Rate
g = Constant Growth Rate
Formula for Calculating Market Discount Rate - Answer- r = R + g
R = Cap rate
g = Constant growth rate
Nominal GDP vs. Real GDP - Answer- Nominal GDP: A country's economic output
without an inflation adjustment
Real GDP: A country's economic output adjusted for the effects of inflation
True or false - In practice, the PV or IRR approaches, rather than the NPV, are the most
insightful unleveraged DCF analyses and tend to be used by most real estate
professionals. - Answer- True
Once expected cash flows have been forecast and a discount rate has been
determined, four different approaches can be used to determine the value of or rate of
return for an investment: - Answer- Using Net Present Value (NPV)
QUESTIONS WITH CORRECT
DETAILED ANSWERS
Operating expenses - Answer- Costs a landlord incurs through the operation of a real
estate asset (e.g. property taxes, insurance, maintenance and repairs, management,
utilities, and common area maintenance).
Option (6 examples) - Answer- A clause in a lease that gives the tenant an exclusive
right. It usually includes a period of time during which the option must be exercised.
There are many types of options that can be included in lease agreements, such as:
Renewal Option: Gives the tenant the right to renew their initial lease term upon
expiration of the lease
Expansion Option: Gives the tenant the right to request additional space as their
business needs change
Relocation Option: Grants the landlord the right to provide similar space when they
require the subject space to accommodate another tenant
Right of First Refusal Option: Gives the tenant the right of first refusal to purchase the
real estate asset for a specified price during a specific time frame
Termination Option: Gives the tenant the right to terminate the lease in whole or in part
under pre-negotiated terms. The terms often require the tenant to pay all unamortized
inducements the landlord made when the lease was negotiated, such as tenant
improvements and rent abatement. In addition, the tenant may be required to repay any
unamortized portion of the real estate commissions that were paid.
Re-measurement Option: Gives the landlord the right to re-measure the tenant's leased
space or the entire building and confirm or correct the measurements in accordance
with the measurement standards defined in the lease.
Potential gross income (PGI) - Answer- The maximum income a real estate asset is
capable of producing.
Pro forma statement - Answer- A set of financial projections or forecasts for a real
estate asset that are used to estimate either the value of the asset or a potential return
from purchasing the asset at a certain price.
,Rent abatement - Answer- A period of time where the landlord chooses to forgive some
or all of the basic rent, additional rent, and/or parking rent.
Risk - Answer- The degree of chance an investment will result in a financial loss. It is a
function of the volatility of the expected return.
Vacancy and collection allowance - Answer- An estimate of the amount by which
potential gross income (PGI) should be reduced to account for vacancies (i.e. lease
space that does not generate income) and collection losses (i.e. non-payment of rent).
Performing an unleveraged DCF analysis involves the following three steps: - Answer- 1
Forecasting the expected future net cash flows
2 Determining the discount rate
3 Valuing the investment
A lease abstract - Answer- A lease abstract is a document outlining the key economic
and legal elements of a lease, including a description of the premises, the names of the
parties to the agreement and their primary addresses, net rents and other items of value
(e.g. tenant improvements, escalations), the lease term, and the key covenants and
conditions with references to the relevant page, clause, or exhibits in the lease
agreement. Although there is no substitute for a careful review of each lease
agreement, the rent roll and lease abstracts should provide the key data needed to
prepare a pro forma statement.
rent roll - Answer- The rent roll is a document listing all of the tenants leasing space in a
real estate asset along with the key elements of their respective leases, including the
rent amounts, the date and amounts for future escalations, the start date of the lease,
and the lease term. It also typically lists all income generated by the real estate asset,
such as parking, signage, and storage.
True or false - In addition to carefully reviewing the lease agreements, real estate
professionals representing buyers in commercial real estate trades should ensure they
request the seller provide an Estoppel Certificate for each tenant. - Answer- True - An
Estoppel Certificate confirms the current details of the lease and financial status of the
tenant as of the date on the certificate. Although the form and content of an Estoppel
Certificate is dictated in the lease agreement, it will typically include the following
information:
The commencement and expiration dates of the original lease and extensions or
renewals that have occurred
The basic rent amount
The area of the premises
Any financial or other obligations that remain on behalf of the current landlord to the
tenant (e.g. TI allowance, rent abatement)
The payments (e.g. rent, additional rent) that the tenant has made
,Any pending or current litigation between the tenant and the current landlord
The seller, their real estate professional, or their legal expert typically completes the
Estoppel Certificate as prescribed in the lease agreement and then has the tenant sign
it. Upon receiving the Estoppel Certificate(s), the buyer's real estate professional should
provide them to their client for review.
An operating budget - Answer- An operating budget consists of all revenues and
expenses over a period of time (typically a quarter or a year) and is used to plan an
asset's operations. An operating budget is prepared in advance as a goal the asset is
expected to achieve. Financial statements are a formal record of the current financial
activities and condition of an asset. They are useful for determining the ability of the
asset to generate income and the sources and uses of that income.
Market Analysis - Answer- A market analysis is a study of the supply of and demand for
a real estate asset and/or its space in a geographically-defined area to determine
attributes of products in the market as well as current or expected prices or rents. Often
the analysis includes an investigation of how a particular real estate asset could be
absorbed, sold, or leased under current or anticipated market conditions. It also
identifies trends and events that could have implications for the asset's value.
The following elements are essential for a pro forma statement for the purposes of an
Unleveraged DCF analysis: (x4) - Answer- Initial investment: The initial investment is
the purchase price of the real estate asset plus any costs incurred to acquire it, such as
due diligence and legal costs. Due diligence costs may include fees for environmental
site assessments, building condition assessments, and appraisals, as well as
commissions for the real estate professionals facilitating the transaction. In other words,
the initial investment is the total monetary outlay required to obtain the real estate asset.
Reversionary value: Reversionary value is the estimated value of the asset at the end of
the holding period when disposition occurs. In other words, it is the expected sale price
for the asset, less disposition costs such as legal costs and commissions for the real
estate professionals facilitating the transaction. In other words, it is the total monetary
outlay required to sell the real estate asset.
Holding period
Annual cash flows
An escalation rate - Answer- An escalation rate is a pre-specified increase in the rent or
operating expenses during the term of the lease. The market usually determines the
rate of escalation allowed. The escalation rate is typically based on the following:
Annual Consumer Price Index (CPI) or other index for rent or operating expenses
Flat with escalations of specified amounts at future dates for rent
, Flat with escalations to market rates at future dates for rent
Market Discount Rate - Answer- The market discount rate is a measure of investment
performance over a holding period that accounts for risk and return on capital.
Therefore, the market discount rate is the sum of the following three components:
Discount rate = Risk Free Rate of return + Risk Premium + Constant Growth rate
The risk free rate of return - Answer- The risk free rate of return is what you would
expect from an investment that has no risk of default. Government backed securities are
generally believed to be risk free. Assuming the typical holding period of a real estate
asset is five years, the risk free rate of return can be based on the return for a five-year
Government of Canada treasury bond as it is risk-free investment.
the real rate - Answer- The real rate consists of what remains of the return after
accounting for inflation.
Gordon Growth Model (GGM) - Answer- The GGM, sometimes called the dividend
growth model or growing perpetuity model, is traditionally used in finance to value
stocks with dividend growth. Real estate assets tend to have annual income that grows
fairly steadily over time, much like the dividend of a mature company, so the GGM can
also be applied in this situation.
Formula for the Gordon Growth Model - Answer- Value = Dividend / r-g
Dividend = Cashflow
r = Discount Rate
g = Constant Growth Rate
Formula for Calculating Market Discount Rate - Answer- r = R + g
R = Cap rate
g = Constant growth rate
Nominal GDP vs. Real GDP - Answer- Nominal GDP: A country's economic output
without an inflation adjustment
Real GDP: A country's economic output adjusted for the effects of inflation
True or false - In practice, the PV or IRR approaches, rather than the NPV, are the most
insightful unleveraged DCF analyses and tend to be used by most real estate
professionals. - Answer- True
Once expected cash flows have been forecast and a discount rate has been
determined, four different approaches can be used to determine the value of or rate of
return for an investment: - Answer- Using Net Present Value (NPV)
