RECA Commercial EXAM 2 Correctly Solved 100% Pass

RECA Commercial EXAM 2 Correctly Solved 100% Pass Commercial real estate assets have a number of attributes that make them unique relative to other types of investments. These attributes include the following: (x10) *ANS* 1. They involve land 2.Transaction time frames are long 3. Transaction costs are high 4. they are expensive 5. They are long lasting 6. Highly regulated 7. have a long production cycle 8. are management intensive 9. are heterogeneous 10. Involve measuring return on investment 1. Long-lasting, Durable Goods 2. Expensive, High-valued (left for well capitalized investors) 3. Transaction Costs: Due diligence and commissions alone comprise about three to five percent of transaction costs. 4. Transaction Time Frame 5. Land 6. Heterogeneous: every parcel of land is unique so every commercial real estate asset is unique. However, improvements are rarely identical as unique site characteristics, land use regulations, and the market often require different solutions from developers. 7. Return Measures 8. Management Intensive 9. Long Production Cycle: it takes time to develop and construct new commercial real estate assets to meet the needs of the expanding population. This results in the real estate supply being relatively slow to respond to changes in demand (i.e. inelastic supply). 10. Highly Regulated Inelastic supply *ANS* there is a limited supply. To illustrate, many cities are geographically constrained and have a Land Use Bylaw that limits the ability to change the use of a parcel of land. This results in a relatively inelastic supply of land for commercial purposes. Inelastic supply means the supply cannot readily adjust to changes in demand or price. four major commercial real estate asset product types according to Real Capital Analytics *ANS* Office: Refers to real estate primarily used for office space Retail: Refers to retail properties, such as strip centres or neighbourhood, community, regional and super-regional shopping malls Industrial: Refers to real estate for industrial use, such as distribution, manufacturing, or warehouse facilities and data centres Apartment: Refers to multi-family rental properties. Other miscellaneous product types include hotels, leisure (e.g golf courses), and special use (e.g. casinos) 3 miscellaneous product types *ANS* hotel, leisure (e.g. golf courses), and special use (e.g. casinos). Categorization by Building Class *ANS* For example, office properties are often categorized as Class A, B, or C. Categorization by Number of Storeys *ANS* For example, apartment properties are classified as either garden complexes (one or more low-rise buildings consisting of four storeys or less) or mid/high-rise projects (one or more buildings consisting of four storeys or greater). Categorization by building's Property Location *ANS* For example, in addition to building class, office properties are often categorized based on their location as either central business district (CBD) or suburban. Categorization by building's Type *ANS* For example, the International Council of Shopping Centres (ICSC) defines different types of shopping centres according to size (gross leasable area and land area), types of tenants, and trade area. The length of time for the Commercial Real Estate Asset Life Cycle process varies considerably depending on a number of factors, including the following: (x5) *ANS* The real estate asset's product type The size and complexity of the project The regulatory environment The need for related infrastructure The financial and operational capability of the investor(s) A typical commercial real estate asset undergoes three phases during its life cycle: *ANS* Phase I: Land Acquisition and Development Phase II: Building Construction Phase III: Operations and Asset Management Phase I: Land Acquisition and Development During Phase I, the developer acquires the land and undertakes the necessary development and pre-construction work. This involves the following: (x3) *ANS* Completing a feasibility analysis Enlisting the professional services of planning specialists, architects, engineers and contractors, and marketing experts Soliciting capital providers (e.g. investors, lenders) True or False - With the exception of a multi-family project, usually some pre-leasing must be in place. *ANS* True - Capital providers often require pre-leasing, which involves obtaining lease commitments in advance of construction. In fact, a construction lender may not commit construction funds until there are leasing commitments for a certain percentage of the space. With the exception of a multi-family project, usually some pre-leasing must be in place. Once lease up of the rest of the asset is complete (i.e. full occupancy), most of the risk associated with the development is eliminated. Four professional organizations that represent both property management and asset management professionals. *ANS* Building Owners and Managers Association (BOMA) Institute of Real Estate Management (IREM) National Council of Real Estate Investment Fiduciaries (NCREIF) Real Property Association of Canada (REALpac) True or False - In the process of operating and maintaining a real estate asset, the property manager is responsible first to the tenant *ANS* False - In the process of operating and maintaining a real estate asset, the property manager is responsible first to the investor and second to the tenants. The property manager is expected to follow the investor's lawful instructions. Asset Management *ANS* The property manager typically reports to the asset manager. Asset management involves maximizing the value of a real estate asset or a portfolio of real estate assets according to the objectives defined by the investor. Different investors have different objectives and maximizing value may only be one of them. The property manager provides the following reporting: monthly (x3) , Annually (x3), for the purpose of (x3) *ANS* Monthly: Accounting Operations Leasing performance Annually: Operating expenses Capital Budget Cash flow For: Fianancial Control Performance measurement Trends detection and pre-emptive actions The Asset manager provides the following reporting: monthly (x3) , Annually (x2), for the purpose of (x2) *ANS* Monthly: Strategic Issues Cash Flow Debt Annually: Budget Long-Term Planning For: Performance Measurement Financial Planning Property Manager must hold a license in order to: (x8) *ANS* Soliciting a property owner to lease their premises Marketing properties for lease Soliciting a tenant to lease a premises Negotiating or re-negotiating a lease between a tenant and landlord (landlord includes the owner or a person who controls the right of disposition for the property) Approving real estate leases Holding money in relation to a lease agreement Collecting, offering, or attempting to collect money payable as rent Any activity furthering these activities directly or indirectly The asset market *ANS* The asset market is the market for real estate assets. Sometimes known as the property market, this is the market where investors purchase and sell real estate assets. The space market *ANS* The space market is the market for the real estate uses. The term space denotes the physicality of real estate in that it ultimately provides a physical location and/or shelter for the activities that take place within that space. Since the characteristics of the space market are often tied to the use of the real estate within that market, space markets are typically delineated by their functionality. Thus, the term office space market refers to the use of real estate to provide shelter to firms for their employees to conduct business. Similarly, the residential space market refers to the use of real estate in providing shelter from the natural elements for individuals or households. supply relationship *ANS* The correlation between price and how much of a good or service is supplied to the market is known as the supply relationship The key non-price determinants of supply include the following: (x5) *ANS* Cost of production State of technology Expectations of producers Number of suppliers in the market Government taxes and subsidies Movements (Movements vs. Shifts in Supply) *ANS* Movements: Movements along the supply line occur when a change in quantity supplied is caused only by a change in the price. As the price increases, the quantity supplied increases as displayed by movement along the supply line from point B to point C. Conversely, as the price decreases, the quantity supplied decreases as displayed by the movement along the supply line from point B to point A. Shifts (Movements vs. Shifts in Supply) *ANS* While changes in the price of a product or service result in movements along the supply line, shifts in the supply line occur when there are changes in an influencing factor other than the price. Some of the influencing factors other than price that can cause a shift in supply include the following changes in: (x5) *ANS* Costs of production State of technology Producer expectations Number of suppliers in the market Government taxes and subsidies Note: same as "The key non-price determinants of supply" The theory of demand *ANS* The theory of demand states that, the price and quantity demanded in a given market are inversely related. That is, the higher the price of a product, the less of it people are prepared to buy (assuming other factors are unchanged). demand relationship *ANS* The correlation between price and how much of a good or service is demanded in the market is known as the demand relationship price is not the only determinant that affects demand. The key non-price determinants of demand include the following: (x6) *ANS* Market size Consumer's expectations Availability of credit Consumers' disposable income Consumers' tastes and preferences Price of substitute of complementary products Movements Versus Shifts in Demand Movements (Movements Versus Shifts in Demand) *ANS* Like movements along the supply line, movements along the demand line from one point to another occur only if there is a change in the price of the product or service which leads to a change in the quantity demanded. Shifts (Movements Versus Shifts in Demand) *ANS* Shifts in the demand line occur when there is a change in an influencing factor other than the price of the good or service. Some of the influencing factors other than price that can cause a shift in demand include the following changes in: Consumer expectations Number of consumers Consumers' disposable income or wealth Consumer tastes and preferences Price of substitute or complement products equilibrium *ANS* In economics, the term equilibrium is used to refer to a state of balance between supply and demand forces. Where the supply and demand lines intersect, the market is said to be at equilibrium. At the intersection point, the price that consumers are willing to pay and that producers are willing to accept is equal. This price is often called the equilibrium price. In addition, the quantity of goods that are being supplied to the market is the same amount that is being demanded. At the given price of equilibrium, suppliers are selling all the goods that they have produced and consumers are receiving all the goods that they are demanding. Market Surplus *ANS* A market surplus is a state of disequilibrium whereby the quantity supplied exceeds the quantity demanded at the current price. A market surplus occurs only if the current price exceeds the equilibrium price. The higher price generates a smaller quantity demanded and a larger quantity supplied than needed for equilibrium. When a surplus occurs, sellers will begin to reduce the prices in order to clear their inventory. As the price decreases, there will be a decrease in the quantity supplied and an increase in the quantity demanded until the equilibrium price is once again achieved. Market Shortage *ANS* A market shortage is a state of disequilibrium whereby the quantity demanded exceeds the quantity supplied at the current price. A market shortage occurs only if the current price is lower than the equilibrium price. The lower price generates a larger quantity demanded and a smaller quantity supplied than needed for equilibrium. When a shortage occurs, sellers are likely to raise their prices. As the price rises, there will be an increase in the quantity supplied and a reduction in the quantity demanded until the equilibrium price is achieved. production cycle *ANS* The production cycle is the period of time over which new inventory can be added to the current stock of space. The production cycle differs depending on the real estate asset product type (e.g. office, industrial). In the short run, the supply of space usually cannot be easily adjusted for increases in demand as it takes time for developers to acquire municipal approval for new developments to construct new assets or convert existing assets (e.g. repurposing warehouse space into office space) and add to the current supply. This means that the supply of space is relatively inelastic in the short run. Why do major employers usually plan ahead for relocations or significant increases in employment levels? *ANS* due to inelastic supply, major employers usually plan ahead for relocations or significant increases in employment levels to avoid space shortages, consequent high rental rates, and possible overcrowding of existing office space. The market cycle for real estate assets flows through four phases, with Phase 1 repeating after Phase 4. The four phases are as follows: *ANS* Recovery Expansion Hypersupply Recession True or False - Market classifications for the four major comercial real estate product types include office, building class, property location, and retail *ANS* False, Markets for the four major commercial real estate types are often categorized by building class, number of stories, property location and type. Commercial Investment types include: (x12) *ANS* Individual ownership Co-ownership Partnerships Joint ventures Corporations Real estate investment trusts Real estate operating companies Exchange-traded funds Commercial mortgages Mortgage investment corporations Commercial mortgage-backed securities Crowdfunding General partnership vs Limited partnership *ANS* General partnership: A partnership consisting of partners who are jointly and severally liable for the debts of the partnership and who have unlimited liability. Limited partnership: A partnership consisting of limited partners and at least one general partner. Limited partners have limited liability, meaning they are liable for the debts of the partnership only to the extent of their investment in the partnership. A Joint Venture is similar to a partnership in that it is created when two or more entities enter into a contractual agreement together. However, a JV differs from a partnership in many ways, including the following (x6) *ANS* JV participants share specific income and expenses related to the project as opposed to sharing in the total profit or loss JV participants can claim their own expenses against their share of the project income JV participants can combine resources to create a larger operation, yet maintain ownership of their respective resources JV participants are usually only able to bind themselves contractually, as opposed to binding all participants A JV only exists for a specified period of time as it is typically created to meet a specific goal Liability for debts can be completely limited in a JV by having each entity state they will each pay for their own expenses and cannot make any agreements that bind the others A JV is not a legal entity from a tax perspective. If an investor is involved in a one-time transaction with a party that they do not intend to continue to do business with, a JV is usually the appropriate avenue for tax reasons. True or False - If a corporation was formed in another province but owns land in Alberta, it must register to do business in Alberta. Owning land in Alberta is one of the criteria the provincial government uses to determine if a corporation is carrying on business in Alberta. *ANS* True What real estate professionals do to verify if the corporation has been registered in Alberta? *ANS* To verify if the corporation has been registered in Alberta, real estate professionals must order a corporate search through Service Alberta's Corporate Registry. Federally registered corporations can be searched through Corporations Canada. Real Estate Investment Trust (REIT) *ANS* A real estate investment trust (REIT) is a private or public organization that invests predominantly in commercial real estate assets through either direct ownership or mortgage investments. The concept had initially been introduced in the United States in 1960 to provide investors with the opportunity to participate in different sectors of the real estate market indirectly by owning shares in an entity that owned a significant portfolio of real estate assets. REITs have existed in Canada for over 20 years, with the first Canadian REIT formed in 1993 when a real estate mutual fund converted to a closed-end mutual fund trust. closed-end mutual fund trust *ANS* A closed-end mutual fund trust is a flow-through entity so income earned by trust can flow through to unit holders without the trust being subject to taxation. Canadian Real Estate Investment Trust (CREIT), which listed in September 1993, and RioCan Real Estate Investment Trust (RioCan), which listed in November 1993, are still thriving today. How to REIT's avoid paying income tax *ANS* REITs qualify as a special kind of mutual fund trust (MFT), although they are not mutual funds as defined by securities legislation. This means they are able to avoid paying income tax if, once expenses have been paid, 85% - 95% of the taxable income that remains is paid to unit holders as cash distributions. These distribution levels must be maintained for a REIT to avoid paying income tax. hypothec *ANS* A hypothec is a right linked to a property. This right is given by one person (i.e. the debtor) to another person (i.e. the creditor) to ensure that an obligation will be respected. Mortgage REIT *ANS* A mortgage REIT is a real estate investment trust that invests in mortgages as opposed to real estate assets. Real Estate Operating Companies (REOCs) *ANS* Real Estate Operating Companies (REOCs) are publicly traded corporations that own real estate assets. Investors that own real estate assets but also own the business that uses the asset and thus have a significant operation or management component to their activities usually choose to be REOCs. Examples include hotels and senior housing or extended care facilities and related businesses. The reason investors choose REOCs is that their ability to reinvest cash flow in the company is not limited . Investors in REOCs often seek capital gains rather than passive cash flows. REOCs often reinvest earnings back into the business rather than distributing them as dividends to unit holders. Also, REOCs have more flexibility in the range of activities they can undertake. Under securities legislation, a REIT qualifies as an MFT for a particular taxation year if throughout the year it is resident in Canada and meets each of the following tests: (x4) *ANS* Property Test Passive Revenue Test Real Property Revenue Test Qualifying Property Value Test Exchange-Traded Fund *ANS* An exchange-traded fund (ETF) is a marketable security that tracks an index or a basket of assets like an index fund. A marketable security is a financial instrument that can be easily converted to cash. An index fund is a mutual fund with a portfolio that tracks components of a market index. Mortgage Investment Corporation *ANS* A mortgage investment corporation (MIC) is designed specifically for mortgage lending in Canada and is a flow-through entity. Owning shares in a MIC enables investors to participate in a diversified mortgage pool. A MIC portfolio can include everything from a small second mortgage on a residential property to commercial and construction mortgages on new projects. A typical MIC loan does not exceed 75% - 85% of the current value of the property being mortgaged. Commercial Mortgage-backed Securities *ANS* A commercial mortgage-backed security (CMBS) is a bond secured by one or more commercial mortgages. A bond is a fixed income investment in which an investor loans money to an entity that borrows the money for a defined period of time at a variable or fixed rate of interest. risk premia *ANS* risk premiums risk premium *ANS* A risk premium is the increment above the risk-free rate of return that an investor requires as compensation for the additional risk associated with investing in a particular real estate asset or real estate asset class. Specifically, it is the difference between the return on a risk free investment, such as a Government of Canada treasury bond, and the expected return for the investment in question. Investment objectives are related to what the investor wants to achieve from their investment portfolio. Generally, there are two objectives: *ANS* a risk objective and return objective. These objectives are interdependent as the risk objective defines how high the investor can place the return objective. constraints related to any investment (x4) *ANS* Market timing preference Investment Horizon Liquidity Management Intensity Fiduciary Duty *ANS* A legal obligation of one party to act in the best interest of another. Risk related to investment in commercial real estate assets can be classified into four categories: *ANS* Asset-level risk Enterprise or Entity-level risk Non-systematic risk Systematic risk negative covariance *ANS* Real estate assets have negative covariance if their returns move in opposite directions as a result of market changes. Investing in real estate assets with negative covariance usually reduces the portfolio's overall return, but is also less risky. Systematic risk *ANS* Systematic risk is risk that results from market-wide economic factors, such as inflation, interest rate changes, currency fluctuations, and natural disasters. This type of risk cannot usually be avoided, although some investments may be less subject to market fluctuations arising from economic forces. For example, a senior's housing facility may be a more stable investment as most seniors do not depend on employment for income, and their incomes in many cases are fixed. Systematic risk can be reduced through careful research prior to making an investment. Changes in the regulatory or political environment can be anticipated with careful research into the local, regional, and national landscape. Participation in relevant industry organizations may also provide insight and an avenue to contribute to the decisions being made. In addition, although a detailed market analysis cannot anticipate unexpected events, it can provide the investor with a good understanding of current and expected market conditions. In today's economy, systematic risks can also be mitigated by investing globally. Investors can reduce country-specific risks by investing internationally. For example, most Canadian pension funds invest in assets in other countries to diversify their real estate portfolios. Asset-level risk *ANS* Asset-level risk is the risk inherent to a specific real estate asset. This type of risk can be reduced through careful due diligence at acquisition by assessing the current condition of the asset's components to estimate expected future capital expenditures. Capital expenditures are significant expenses required to maintain the condition of a real estate asset (e.g. replacement of a roof or a heating and ventilation system). Asset-level risk can be further mitigated through competent asset management and property management. The following are examples of ways to manage asset-level risk: Leases with national tenants are usually less risky than leases with local tenants. National tenants are businesses with operations across Canada while local tenants are businesses that exist only within a certain area, such as a neighbourhood or city. A fully occupied building is usually less risky than a building that has vacancies. Well-maintained buildings are less risky than buildings with significant deferred maintenance. Financing that involves fixed interest rates is less risky than financing involving variable interest rates. A portfolio of assets is less risky than a single asset due to diversification. Enterprise or entity level risk *ANS* Enterprise or entity level risk is risk related to the investing entity (e.g. an individual, a private or public corporation, a partnership, or a private or public REIT). This type of risk largely has to do with the financial condition and the management of the entity. It does not directly relate to a real estate asset. For example, if an entity's managers lack experience with a certain real estate asset class that they have invested in (e.g. hotels), the risk is higher for investors in that entity. Such risk can be managed through careful hiring practices and monitoring the entity's investment strategy. For example, lenders carefully assess borrower experience with an asset class as part of their underwriting process. The entity's financial state and the objectives of its managers determines their approach to investment analysis and investment decisions. For example, the entity's ability to sustain an investment in the event of a downturn or an unanticipated event should be part of the investor's analysis. Non-systematic risk *ANS* Non-systematic risk is the risk specific to an industry or a class of assets. Typical non-systematic risks include market risk or political or regulatory risk. This type of risk can be reduced through a diversified portfolio of investments. A diversified portfolio consists of several investments with different risk levels. With a diversified investment portfolio, the risk of the individual assets is unchanged but all the assets together generate a lower and less volatile return to the investor. For example, an investment in an office building where tenants' businesses are subject to national and local employment fluctuations could be diversified through another investment in a seniors' housing facility. While the return may be lower, the risk of the combined investment is less due to inclusion of an asset with a less volatile return. Similarly, a developer might reduce political or regulatory risk by investing in land in multiple jurisdictions. Non-systematic risk can be further reduced by investing in real estate assets with negative covariance. Real estate assets have negative covariance if their returns move in opposite directions as a result of market changes. Investing in real estate assets with negative covariance usually reduces the portfolio's overall return, but is also less risky. If investors wish to earn greater returns, they can adjust the portfolio weights, but only if they are willing to take on more risk. Historic data serves a number of purposes, including the following: (x4) *ANS* Providing insight into how an asset has performed relative to other assets Providing insight into how an asset has performed in different market conditions Providing insight into risk premia or relative returns among alternative investments Establishing expectations regarding future returns Periodic Income *ANS* All income received on a regular basis. It includes rent, dividends, or distributions less expenses, and is usually measured on a pre-tax basis. In Canada, there are two main indices that investors refer to for data on current and historic commercial real estate returns: *ANS* S&P/TSX Capped REIT Index (public transactions) REALpac/IPD Index (private transactions) S&P/TSX Capped REIT *ANS* The S&P/TSX Capped REIT Index tracks a subset of public REITs listed on the Toronto Stock Exchange (S&P/TSX). However, the S&P/TSX Capped REIT Index does not report total returns. A total return index *ANS* A total return index shows the theoretical growth in value of a share over a specified period, assuming dividends are reinvested to purchase additional shares at the closing price applicable on the ex-dividend date (i.e. the date on which an entity must be a shareholder to receive a dividend). Gross dividends (i.e. the sum of all dividends paid to investors) are used where available and the calculation ignores taxes and re-investment charges. Adjusted closing prices are used throughout to determine the price index and hence the return index. Dividends are allocated over the year to the share prices in calculating the total return with daily returns adjusted by 1/260th of the dividend. This calculation is based on the assumption there are 260 weekdays in the year. The total return index that measures the day-to-day performance of the subset of public REITs on the S&P/TSX is the Blackrock iShares S&P/TSX Capped REIT Index ETF. REALpac/IPD Index *ANS* The REALpac/IPD Index is a private commercial real estate index that tracks the performance of institutional-grade real estate assets across Canada. Institutional-grade real estate assets are relatively high quality, low risk properties. The returns of this index are frequently used by large institutional investors. The REALpac/IPD Real Estate Index for Canada is constructed similarly to other indices of institutional-grade real estate investments globally. Morgan Stanley Capital International (MSCI) is the publisher of the REALpac/IPD Index and establishes the data standards for the index.11 MSCI collects the data and tracks returns on a quarterly basis. Each participant reports the income generated for each commercial real estate asset it owns, excluding any capital expenditures, and a real estate appraisal of each asset. As a result, for each quarter, there is a return reflecting the periodic income and capital appreciation/depreciation for each asset. These returns are then aggregated to create the index. Capitalization Rate *ANS* The capitalization rate (cap rate) is the ratio of a real estate asset's current net operating income (NOI) divided by the asset's estimated market value. NOI / estimated market value Are cap rates alone are sufficient to act as a benchmark for performance of a real estate asset. *ANS* No, Unfortunately, cap rates alone are not sufficient to act as a benchmark for performance of a real estate asset. capital stack *ANS* The financial structure of most commercial real estate investments is often referred to as the capital stack. The capital stack illustrates the layers of financing that fund the purchase or improvement of a commercial real estate asset. Investors use the capital stack to evaluate the risk factors, the probability of cash flow, and the overall feasibility of their investment. There are two types of capital that make up the capital stack: *ANS* Equity: An ownership interest in the real estate asset. Debt: One or more loans given to the equity owner(s). Debt is typically secured (i.e. collateralized) by the asset itself and/or other assets of the equity owner(s). Which of the following loan types permits a lender to convert a loan into an ownership stake should the borrower default? First Loan Mezzanine Loan Junior Mortgage *ANS* Mezzanine Loan Four Quadrants of Commercial Real Estate Investment. The concept divides commercial real estate investment into the following options: *ANS* Private Equity: Involves direct investment in commercial real estate assets. Public Equity: Refers to purchasing shares or units in publicly traded commercial real estate companies. Private Debt: Comprises of loans typically secured against real estate assets. Public Debt: Represents public real estate debt instruments. True or False - The capital stack is used by investors to evaluate the risk factors, probability of cash flow and overall feasibility of their investment. *ANS* True - The capital stack illustrates the layers of financing used to acquire a commercial real estate asset and the relationship between equity and debt. True or False - A REIT is not required to distribute its taxable income after expense to unit holders. *ANS* True - There is no requirement to distribute income, However, distributing 85-95% of a REIT's taxable income is recommended for a favourable tax treatment. True or False - A REOC is the best option for an investor that owns a real estate asset and the business who will be using it. *ANS* True - REOCs are popular among investors who own real estate assets and the businesses that use them because they seek capital gains rather than passive cash flows. REOCs are able to reinvest earnings in the company rather than having to distribute them as dividends to unit holders. True or False - A CMBS is a bond secured by one or more commercial mortgages (Commerical morgage-backed securities) *ANS* True, Payments form several mortgages are pooled together , divided up and passed on to investors as bonds. This per its the banks to sell off existing mortgages and access new capital, and thus making more mortgage loans. True or False - The opportunist investment strategy would involve a real estate asset that requires renovation, adaptive re-use, or other repositioning techniques to improve the asset's value in the market *ANS* False - An opportunist strategy includes assets for which much of the risk in the acquisition phase is still present, assets that require recapitalization, and assets that need repositioning due to high vacancies or non-performing loans. True or False - Non-systematic risk results from market-wide economic factors, such as inflation, interest rate changes, currency fluctuations and natural disasters. *ANS* False (that would be systematic risk). Non-systematic risk is specific to an industry or a class of assets True or False - The greater the real estate investment risk the higher the reward. *ANS* False. - A higher risk usually indicates the possibility of a higher return, but there are no guarantees. True or false - the total return on an investment is comprised of the periodic income and capitalization rate. *ANS* False - The total return is comprised of the periodic income and the capital appreciation/depreciation pro forma *ANS* forcasts the cash flow of a real estate asset to estimate its value or potential return The term pro forma is Latin and means 'for the sake of form.' A pro forma can also be used to do the following: (x3) *ANS* Assess financial options Provide input into property or asset management decisions Evaluate leasing alternatives, capital expenditure options, or disposition alternatives PGI (meaning plus formula) *ANS* Potential Gross Income Rental Income + Miscellaneous Income = Potential Gross Income PGI is the maximum income the real estate asset is capable of producing PGI is also often referred to as gross potential income, gross income, or gross revenue. EGI (meaning plus formula) *ANS* PGI - Vacancy and collection allowance = Effective Gross Income EGI is the income available to pay the operating expenses of the real estate asset and provide a return to the landlord Effective gross income (EGI) is what remains after the vacancy and collection allowance has been subtracted from PGI. EGI is the income available to pay the operating expenses of the real estate asset and provide a return to the landlord. NOI (meaning plus formula) *ANS* EGI - Operating expenses = Net Operating Income the net income earned by the property Net Effective Rent and Market Rent *ANS* Net effective rent and market rent are terminology often used in leasing. Net effective rent, or sometimes simply referred to as effective rent, is rent that accounts for the actual rent amount and any items of value related to the lease. Market rent would be equivalent to the net effective rent if the landlord did not incur any costs to lease the space to the tenant. However, this is almost never the case. In Alberta, market rent tends to refer to the current annual net rent. Sometimes it will account for any tenant improvement allowances and/or the early occupancy period offered in current leasing transactions. Often a range is quoted for each of these items. However, the few factors on which market rent is generally calculated do not capture all the information included in a more carefully computed net effective rent. When market rent is communicated, it is important for real estate professionals to determine how the figure was derived and discuss with their client all other items of value in the transaction that may not have been accounted for in the market rent. economic covenants (one of two types of lease covenants that generally effect PGI) *ANS* Directly affect the income generated by the real estate asset. Economic covenants might include: Rent Escalations Tenant improvement allowance Rent abatement Operating expenses Parking (generally for office and multi-family properties) Options non-economic covenants (one of two types of lease covenants that generally effect PGI) *ANS* No direct effect on the income generated by the real estate asset but potentially impacts the value of the space to a tenant relative to other alternatives. Non-economic covenants might include: Signage Exclusivity Parking (generally for retail properties) Visibility A continuous operations clause (i.e. operating hours are pre-set) True or false - Economic vacancy is more useful than physical vacancy in calculating NOI *ANS* True two types of vacancies: *ANS* physical and economic Physical is unrented space (like it is not rented out but could be), economic is when it is not rented out for a reason, like rented in July starting in September months when no rent comes in, space used for marketing the building, etc. CAMs *ANS* Common area maintenance (CAMs). CAMs are meant to cover expenses associated with common areas, such as hallways, public washrooms, and other public spaces. However, for some leases involving office properties, all of the typical operating expenses may be included as part of the CAMs. NOI is a before debt and before-tax measure of income. NOI does not take into account the following: (x5) *ANS* Debt service (i.e. payments on loans) Leasing expenses (i.e. expenses incurred by landlords to find and transition tenants into the leasehold space or to prepare the space for a new tenant after an old tenant has left) Capital expenditures (i.e. significant expenses required to maintain the condition of a real estate asset) Depreciation (i.e. apportioning the cost of a tangible asset into an operational expense over the asset's estimated useful life) Amortization (i.e. apportioning the cost of an intangible asset into an operational expense over the asset's estimated useful life) gross lease *ANS* A gross lease is a lease agreement where the landlord is responsible for paying all of the operating expenses for the real estate asset. True or False - Under a gross lease, the income the landlord receives during the lease term is fixed but the operating expenses are not and will generally increase over time. As a result, the NOI for the real estate asset will decrease year per year during the lease term. Because the value of the commercial real estate asset is derived from the income stream it generates, the decreasing NOI results in declining property value for the landlord. *ANS* True net lease *ANS* A net lease is a lease agreement in which the tenant pays their proportionate share of all the typical operating expenses (i.e. property taxes, insurance, maintenance and repairs, management, utilities, and CAMs) for the real estate asset. In a net lease, virtually all of the operating risk is passed from the landlord to the tenant. Investors in real estate assets where the tenants are of high quality and net leases are in place own a very low risk investment and therefore, typically earn a relatively low return. True or False - With net leases, the landlord charges the tenant the actual costs borne by the landlord. *ANS* False - With net leases, reimbursements are included in the calculation of PGI. The landlord typically pays some or all of the operating expenses upfront and charges the tenant a monthly amount estimated on the prior year's budget and the tenant's proportionate share, not by the actual costs borne by the landlord. At the end of the fiscal year, the actual operating expenses paid by the landlord are calculated and any overpayment or underpayment made by the tenant is adjusted accordingly. Net-net-net lease *ANS* In a net-net-net lease, or NNN lease, the tenant pays all or part of the three "nets" property taxes, insurance, and common area maintenance items, on top of a base monthly rent. Management fees are usually added in the fees reimbursed to the landlord, along with common area utilities and operating expenses: For example the cost of staffing a lobby area attendant in an apartment complex would be part of the net-net-net fees. Tenants of course would pay the costs of their own occupancy including janitorial services, utilities as well as their own insurance and taxes Reimbursement income *ANS* reflects the operating expenses reimbursed to the landlord by the tenants. True or false - NOI accounts for asset depreciation *ANS* False - Net operating income does not take into consideration account depreciation, debt service, leasing expenses, capital expenditures or amortization, Calculation for "Break-even occupancy" (also sometimes referred to as the break-even ratio *ANS* break-even occupancy = (operating expenses + Debt service) / PGI Calculation and meaning for Free and Clear Return *ANS* NOI or unlevered pre-tax return (i.e. return before a business pays its financial obligations) on investment as a percentage of a total purchase price or total construction costs Free and clear return = NOI or Unlevered return / Total purchase price or total construction costs Calculation and meaning for Gross Income Multiplier *ANS* The ratio of the purchase price to the annual gross income at the date of the sale. This ratio is sometimes used to estimate the value of multi-family rental properties. A gross income multiplier is only a rough measure of value as it does not consider the cost of utilities, taxes, maintenance and repairs, and vacancies in its calculation. Gross Income multiplier = Value / Annual Gross Income Calculation and meaning for operating expense ratio *ANS* operating expense as a percentage of potential gross income. The operating expense ratio looks at what it costs to operate a real estate asset compared to its income. This ratio is used to compare the expenses of similar properties. Sometimes this ratio is calculated as a percentage of effective gross income (EGI). Some expenses vary depending on vacancy so EGI may be more useful. Operating expense ratio = Operating expenses / Potential Gross income Calculation and meaning for P/E Ratio *ANS* Price to Earnings ratio is a company's current share price relative to its per-share earnings. The earnings per share is forward estimated earnings and can be used for valuation purposes. P/E Ratio = Market Share Price / Earnings per share For example if a company reports earnings per share of $2 and the stock is selling at $20, the P/E ratio is 10 10 = $20 / $2 Published P/E ratio data includes information about real estate income trusts (REITS). The P/E ratio is the inverse of the capitalization rate Calculation for Cap Rate *ANS* The ratio of net operating income (NOI) to the value of the real estate asset. R = NOI / Value Formula for capitalizing net operating income into value *ANS* Value = NOI / R Formula for value *ANS* value = NOI / R Cap rates are used in multiple ways: (x4) *ANS* To estimate the value of an asset To track how the market is valuing various kinds of real estate assets To compare returns on commercial real estate assets to returns on other investments To estimate a market discount rate (i.e. the interest rate used in discount cash flow analysis Does NOI include leasing expenses or capital expenditures? *ANS* No, NOI only accounts for regularly occurring expenses. It usually does not include leasing expenses or capital expenditures as they occur on an irregular basis. Leasing expenses *ANS* Leasing expenses are expenses incurred by landlords to find and transition tenants into the leasehold space or to prepare the space for a new tenant after an old tenant has left. These expenses are usually incurred at the start or end of a lease. Examples of leasing expenses include providing tenant improvements, legal fees associated with the review of the lease, and commissions payable to real estate professionals associated with prospecting the tenant and the lease negotiation. capital expenditures *ANS* A realistic risk-adverse investor must consider how to maintain and, as necessary, replace components of the real estate asset as they become outdated, inefficient, undependable, a risk to tenants, or a risk to the asset. Building systems, including the HVAC, plumbing, electrical, roof, elevator, landscaping, building envelope, and sprinkler system all depreciate and eventually need to be upgraded or replaced. Creating a replacement reserve consistent with industry averages is one way of dealing with this challenge. In this case, a percentage of gross income or a dollar amount per square foot is set aside on an annual basis so that funds are available for these purposes. Below-the-line expenses *ANS* irregular occurring expenses that are critical for maintaining the real estate asset's income stream and value. Adjusted NOI *ANS* the net income earned by the asset, accounting for the below-the-line expenses. Stabilized Rental Income *ANS* rental income the real estate asset is expected to generate at market quilibrium Stabilized vacancy and collection allowance *ANS* vacancy rate expected for the real estate asset at market equilibrium stabilized adjusted NOI *ANS* the stabilized net income earned by the asset, accounting for below-the-line expenses. (stabilized to represent what would normally be expected). The return for a treasury bond consists of two components: *ANS* the expected inflation and the real rate. The real rate consists of what remains of the return after accounting for inflation In addition to differences in investor risk perception between real estate asset classes, cap rates for specific properties within a real estate asset class can vary for several reasons, including: (x6) *ANS* Tenant quality Lease agreement covenants and conditions Building age, design, and quality Elevator and lift systems Parking ratios Transit accessibility What can cap rates tell you about the property? Select all that apply. 1.The approximate value of a property earning capability of a property 3.A property's suitability for redevelopment 4.The potential gross income of a property *ANS* 1 and 2 - Cap rates can be useful in determining the approximate value of a property and estimating the earning capability of a property. The cap rate is not as beneficial in determining whether the property is suited for redevelopment or determining potential gross income. As industry property sales are more infrequent, there are not any recent comparable sales. How else may Rai derive an appropriate cap rate for the property *ANS* use aggregated market data for the property type. Cap rates can be derived from aggregated market data as an alternative to calculating cap rates from comparable properties. Cap rates are published quarterly by all major commercial real estate brokerages and are based on transaction data. What does a real estate market analysis do? *ANS* a market analysis explores the forces that shape the market for a real estate asset's use What does a market analysis begin with? *ANS* A market analysis begins with a study of the supply of and the 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. A market analysis may also be referred to as a market study. What does Macroeconomics study? *ANS* Macroeconomics studies the behavior and performance of large-scale or general economic factors, such as the unemployment rate, growth rate, gross domestic product (GDP), and inflation. A market analysis can provide the user with information about the following: (x7) *ANS* Extent of demand for a particular product type Existing and expected supply of competing products Market rental rates, market selling prices, or cap rates Capacity of the market to absorb new product in a timely manner at an expected price Attributes of competing product Profile of users or investors in the market Effect on public infrastructure, tax revenue, and other fees A market analysis gathers and analyzes the data and information for (x4) *ANS* Macro economy capital markets asset market Space market The last three information sources - rent roll, operating expenses, and capital expenditures - are property specific. Market forces affect a commercial real estate asset at the following three levels: *ANS* Macro Market: Global, national, or regional macroeconomic factors that impact the economic conditions in a regional or metropolitan market. Local Property Market: Local and regional competitive markets for the asset, including past, current, and future market conditions with a focus on supply of and demand for the relevant commercial real estate asset product type. Subject Property Market: Subject market (neighbourhood) conditions for the real estate asset with a focus on supply of and demand for the commercial real estate asset product type, but where the market is narrowed down to substitute product. True or False - a market analysis is a component of a real estate appraisal *ANS* True True or False - Real estate professionals authorized to trade in real estate or to perform property management activities are exempt from requiring a real estate appraisal authorization from RECA *ANS* True - if they are estimating the value of a real estate asset for the purposes of helping a client or prospective client undertake a trade or potential trade in real estate. A potential trade can include providing information to an investor so that they can make a decision to sell the asset, or so that the investor can determine what trade related activities they can undertake (i.e. increase rents) to maximize the value of the asset. Specific users who may benefit from a market analysis include the following: (x8) *ANS* Equity Investors Developers lending institutions Real estate professionals Investment sales professionals Design teams Engineer and contractor project teams Regional and local governments The process to prepare a commercial real estate market analysis includes seven steps: *ANS* Product definition Market identification and delineation Macroeconomic landscape review Market inventory and new supply analysis Demand analysis: historic absorption and economic drivers Vacancy and rent analysis Recent transactions summary and forecast of vacancy and rents The Principle of Substitution *ANS* The Principle of Substitution states that an investor or tenant will pay no more for a property than the cost of acquiring a similar and equally desirable property on the market. Floor Area Ratio (FAR) *ANS* The density of nonresidential land use, exclusive of structured parking, measured as the total nonresidential building floor area divided by the total buildable land area available for nonresidential structures. Office buildings are usually categorized by (x3) *ANS* class, location, and the number of storeys How many stories does a High rise have? (x or more) *ANS* five storeys or more How many stories does a Mid rise office building have? *ANS* 3 - 4 storeys How many stories does a Low rise office building have? *ANS* 1 - 2 storeys local economy can be divided into two sectors *ANS* Basic sector, also referred to as non-local or export Non-basic sector, also referred to as local or non-export Location Quotient (LQ) *ANS* The LQ is a way to quantify the concentration of a particular industry in an urban area or region compared to that of a larger area (i.e. provincially or nationally). It illustrates the uniqueness of a local economy in comparison to a benchmark. The LQ is a ratio comparing a region to a larger reference geography according to some attribute, such as employment, in a particular sector of the economy. For example, if X is the amount of employment in industry X in a region (e.g. manufacturing jobs), and Y is the total amount of employment in the same region (e.g. all jobs), then X ÷ Y is the regional concentration of manufacturing employment in the region. If X' and Y' are similar data points for some larger area, such as Alberta, then the LQ or relative concentration of manufacturing employment in the region compared to the nation can be expressed as (X ÷ Y) ÷ (X' ÷ Y'). A census metropolitan area *ANS* (CMA) is formed by one or more adjacent municipalities centred on a population centre known as the core. A CMA must have a total population of at least 100,000 of which 50,000 or more must live in the core. Base Multiplier *ANS* The base multiplier is the ratio of total employment to basic industry employment. It is a way to estimate the non-basic and basic employment of a region. To illustrate, if the local area has a total of 100,000 jobs, of which 40,000 are basic employment (have an LQ > 1.0), then the local area has a base multiplier of 2.5 (100,000 ÷ 40,000). This multiplier suggests that for every one job in the basic industry or industries, 1.5 non-basic jobs will be created. True or false - Historically, benchmark real estate prices in Alberta have closely followed, though slightly lagging, with the West Texas Intermediate (WTI) spot price of oil. *ANS* True - Though Alberta regions respond differently to these drivers, real estate markets in the province have historically followed fluctuations in WTI oil prices. (New supply) At the macro level, assessing new supply can be obtained through various sources that report building starts and units under construction. These sources include the following: (x4) *ANS* Non-residential building starts are compiled by Statistics Canada on a quarterly basis. Investment is measured in dollars and is split into the categories of Industrial, Institutional, and Commercial. Another measure of future supply is the number and percentage growth of development permits issued by a municipality. Many municipalities in Alberta release in-depth permitting data. For example, the City of Edmonton releases a monthly report identifying the number of permits issued and the construction value, cross-tabulated by permit type in the categories of commercial, industrial, institutional, residential, and miscellaneous. The more direct assessment of future supply is to research projects under construction and in the planning stages. This usually requires gathering information from the local city planning department and monitoring competitors in the market place. One other way to assess new supply is to investigate potential market expansion. However, this component is more difficult to find information on and fraught with more uncertainty. This uncertainty can be minimized by exploring the municipal plans to see if there is the potential for development that might be competitive to the subject property. In Alberta, this involves examining the Municipal Development Plan (MDP), Area Structure Plan (ASP), Neighbourhood Structure Plan (NSP), and land use maps. Although much of the potential development is uncertain, discussion with planning authorities and monitoring the local business news and business networks may allow the determination of future projects, depending on availability of financing or growth in market demand. Municipal Development Plan (MDP) *ANS* Produced by a municipality and creates policies for land use within the entire municipality. Municipalities with a population of 3,500 or more people are required by the Municipal Government Act (MGA) to create an MDP. The municipality must also pass the plan, implement it by passing the applicable Land Use Bylaw, and reference it when reviewing subdivision and/or development applications. Area Structure Plan (ASP) *ANS* Created by a municipality to establish policies for land use, transportation, and servicing for a specific area undergoing new development or intended to undergo new development. ASP may be adopted by a municipality through its bylaw process to provide a design for the subdivision and development of a particular area of land under its jurisdiction. The adoption of these plans is at the discretion of the municipality. If the municipality has an applicable ASP, it is referenced by the municipality when reviewing subdivision and/or development applications that affect the land located within the applicable ASP. Neighbourhood Structure Plan (NSP) *ANS* Provides a concept plan for the future land development and acts as an intermediate link between an ASP and future land use constraints and subdivisions. An NSP presents the vision for a neighbourhood while also meeting stakeholder interests, and complying with sustainable planning principles, and policy and bylaws. Absorption, as a measure of demand *ANS* Absorption, as a measure of demand, is a critical metric when completing a market analysis. Absorption is the total new square footage leased or purchased in the market over a certain period of time. Net absorption is the total new square footage leased, less the total square footage vacated during a certain time period. Net Absorption Formula: *ANS* SF Absorbed (t) = SF Vacant (t-1) + SF Constructed (t) - SF Demolished (t) - SF Vacant (t) In the formula, t represents the time period. Therefore, the amount of square footage absorbed during the period (SF absorbed(t)) equals the square footage vacant at the beginning of the period (SF vacant(t-1)) plus the square footage constructed during the period (SF constructed(t)) less the square footage demolished during the period (SF demolished(t))less the square footage vacant at the end of the period (SF vacant(t)). CBRE *ANS* The abbreviation CBRE stands for Coldwell Banker Richard Ellis. It is the world's largest commercial real estate services and investment firm (based on 2021 revenue) NAICS *ANS* North American Industry Classification System more effective approach for forecasting employment needs (therefore office space needs = demand for office space) = *ANS* A more effective approach would be to use the current square feet per office employee number (178 square feed for 2016) and apply that number to the expected office employee number for 2017 and 2018. The resulting number compared to the 2016 occupied inventory would indicate whether there would be positive or negative expected net absorption. This approach depends on the veracity of the employment forecasts and the space per employee assumption but provides more insight than simply extrapolating past net absorption numbers. True or False - A common purpose for preparing a market analysis is to determine an asking price for a real estate asset. *ANS* False - A market analysis is often prepared to provide input into a financial analysis for the acquisition or disposition of a real estate asset. True or False - A market analysis should offer only the current view of the market, as it is impossible to make meaningful assessments of future movements in supply and demand, *ANS* False True or false - The non-basic sector consists of businesses that depend on local consumers. *ANS* True True or False - If new supply exceeds new demand, vacancy rates should decrease. *ANS* False - If new supply (which includes new construction plus lease terminations less demolitions) exceeds new demand (which refers to the total new square footage leased or purchased in the market), vacancy rates should increase. Additional rent *ANS* The rent equal to the tenant's proportionate share of operating expenses in a net lease. Cash inflow *ANS* Money an individual or company receives. Cash outflow *ANS* Money an individual or company pays. Decimal fraction *ANS* A fraction whose denominator is a power of 10 (e.g. 10, 100, 1000). To convert a percentage into a decimal fraction, move the decimal point two places to the left and remove the percentage sign. For example, an interest rate of 8% as a decimal fraction is 0.08. Holding period *ANS* The time period between an investment's purchase and its sale. In advance *ANS* Payments are made at the beginning of each time period. In arrears *ANS* Payments are made at the end of each time period. Operating Expenses *ANS* 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). Principal *ANS* A sum of money owed as a debt upon which interest is calculated. Replacement reserve *ANS* Funds set aside to provide for the periodic replacement of building components that wear out. Return *ANS* The gain or loss the investor receives as a result of their investment over a specific period of time; typically quoted as an annual percentage. Usually, the return is comprised of income from and changes in value of the asset. Tenant improvement allowance (TI allowance) *ANS* Funds provided by the landlord to pay for all or a portion of the tenant improvements to the leased space. TVM *ANS* Time value of money (TVM) is a pillar of finance not solely specific to commercial real estate, however, it is an important factor when analyzing opportunities for commercial real estate investment. The process of valuing an investment, such as a commercial real estate asset which generates benefits in the form of income and/or value over a long period of time, requires the investor to recognize that a dollar received today is worth more than a dollar received in the future. Discounting *ANS* Discounting is the process of converting future sums of money into their present value. In real estate, discounting is more common as most real estate investment decisions center on the anticipation of future benefits (i.e. cash flows from operations and increases in value) so today's value of those future benefits is crucial for value estimates and comparisons of investment alternatives. These processes are essential components of financial analysis used to determine the value today of cash flows to be received in the future. Present Value (PV) *ANS* The value of a sum of money today Future Value (FV) *ANS* The value of a single sum of money to be received or paid at a certain point in time in the future. Number of Time Periods (N) *ANS* The number of time periods over which an investment is held or loan is repaid Payment (PMT) *ANS* One of a series of sums of money to be received or paid at each time period over the length of time the investment is held. Interest Rate (i) *ANS* The rate that is charged or paid for the use of a sum of money. Interest rates can be expressed as a percentage or as a decimal fraction. Discount Rate (r) *ANS* The rate used to discount a sum or sums of money to be received in the future to their present value True or false - Because FV is being divided, PV will always be less than or equal to FV. *ANS* True An annuity *ANS* An annuity is a series of level payments (i.e. equal payments) received or paid that occur at regular intervals over a specified period of time. common example of an annuity is a mortgage. There are two basic types of annuities: *ANS* Ordinary Annuity: An annuity where payments are received or made at the end of each time period Annuity Due: An annuity where payments are received or made at the beginning of each time period sinking fund *ANS* Periodic payments are made for a sp