CMPS Investor Return on Investment 3 — Questions and Answers
Question 1: An investor uses a 1031 exchange. How does this strategy enhance ROI?
- It eliminates capital gains taxes permanently
- It defers capital gains taxes, allowing full proceeds to be reinvested (Correct answer)
- It converts ordinary income to capital gains
- It increases depreciation deductions on the new property
Correct answer: It defers capital gains taxes, allowing full proceeds to be reinvested
A 1031 exchange defers — not eliminates — capital gains taxes, letting investors redeploy the full sale proceeds into a new property to compound returns.
Question 2: What is the primary purpose of calculating Internal Rate of Return (IRR) for a real estate investment?
- To determine annual depreciation
- To measure the discount rate at which NPV equals zero across the entire hold period (Correct answer)
- To set the asking rent
- To calculate the loan amortization schedule
Correct answer: To measure the discount rate at which NPV equals zero across the entire hold period
IRR is the discount rate that makes the net present value of all cash flows (including sale proceeds) equal to zero, reflecting the true time-value-adjusted return.
Question 3: An investor's property has a gross rent multiplier (GRM) of 10 and annual gross rents of $30,000. What is the estimated property value?
- $3,000
- $300,000 (Correct answer)
- $30,000
- $3,000,000
Correct answer: $300,000
Property value using GRM = Gross Rents × GRM = $30,000 × 10 = $300,000.
Question 4: Which concept describes the return an investor sacrifices by choosing one investment over the next best alternative?
- Net present value
- Opportunity cost (Correct answer)
- Depreciation recapture
- Amortization benefit
Correct answer: Opportunity cost
Opportunity cost is the foregone return from the best alternative investment not chosen, a key factor in evaluating ROI.
Question 5: Depreciation on a residential rental property is taken over how many years under current U.S. tax law?
- 15 years
- 27.5 years (Correct answer)
- 39 years
- 40 years
Correct answer: 27.5 years
The IRS requires residential rental property to be depreciated using straight-line method over 27.5 years.
Question 6: An investor finances a $500,000 property with $100,000 down. If the property appreciates 5%, what is the ROI on equity from appreciation alone?
- 5%
- 25% (Correct answer)
- 20%
- 10%
Correct answer: 25%
Appreciation = $500,000 × 5% = $25,000 gain on $100,000 invested = 25% ROI from appreciation via leverage.
Question 7: A CMPS professional calculates that a borrower's investment property has a break-even ratio of 75%. This means:
- 75% of gross income covers operating expenses only
- 75% of gross income is needed to cover both expenses and debt service (Correct answer)
- The LTV is 75%
- The investor earns a 75% return annually
Correct answer: 75% of gross income is needed to cover both expenses and debt service
Break-even ratio = (operating expenses + debt service) / gross operating income; 75% means the property needs 75% occupancy/income to cover all costs.
CMPS Investor Return on Investment 3
An investor uses a 1031 exchange.
How does this strategy enhance ROI?