Question

1. CAP rates measure

   	A.	Returns from both the yearly cash flows of a property and the sale of property
   	B.	The NOI of multiple years of a property
   	C.	One year of NOI relative to the sales price
   	D.	The NOI and before tax equity reversion of a property relative to the sale price

2. The valuation approach most commonly used for insurance purposes is the

   	A.	Cost approach
   	B.	DCF approach
   	C.	Direct Capitalization
   	D.	Sales Comparison

3. Which of the following is correct about the Capital Stack?

   	A.	The Common Equity holder is more protected than the Preferred Equity holder
   	B.	Senior Debt is in the #2 position in terms of priority
   	C.	Mezzanine investor carries more risk than Senior Debt
   	D.	All equity investors always have decision power

4. Which statement is true about residential real estate cycles?

   	A.	Generally speaking, when real estate values start going down, rents start going up.
   	B.	Subleasing determines the volatility of the real estate cycle
   	C.	Real Estate cycles are predictable
   	D.	They show that it is practically always a landlord's market

Answer 1

1) Cap rate = NOI (net operating income) / sales price, where NOI is for one year. Hence option C is the correct answer.

2) Valuation approach most commonly used for insurance purposes is cost approach. Sales comparison can be used only when recent sales of comparable properties are available. DCF approach can only be used for properties that are generating rents and there is sufficient data on market trends. Direct capitalization requires use of a cap rate which is typically based on market comparables / trends.

3) Common equity holder is junior to preferred equity in the capital stack and hence has less protection. Senior debt has #1 priority in the capital stack. Mezzanine investor is junior to senior debt and thus carries more risk (Option c is correct).    

4) As rents go down, typically NOI and hence property valuation goes down. Real estate cycles, as with other market cycles, are not predictable. In a downturn, people are unlikely to buy new homes and will hence increasingly look to rent. On the other hand, when home prices are rising they may soon become unaffordable and hence people will be forced to rent.