CRS Investment Analysis and Financial Concepts 2 — Questions and Answers
Question 1: What is a 1031 exchange and what is its primary benefit for real estate investors?
- A government program providing first-time homebuyer grants
- A tax-deferral strategy allowing investors to defer capital gains by reinvesting in a like-kind property (Correct answer)
- A loan product designed for investment properties with below-market rates
- An IRS audit process for rental property owners
Correct answer: A tax-deferral strategy allowing investors to defer capital gains by reinvesting in a like-kind property
A 1031 exchange allows investors to defer capital gains taxes by rolling proceeds from a sold investment property into a qualifying replacement property of equal or greater value.
Question 2: What is the debt-to-income ratio (DTI) and why does it matter to residential investors?
- The ratio of a property's debt to its current market value
- The ratio of monthly debt payments to gross monthly income, used by lenders to qualify buyers (Correct answer)
- The relationship between the investor's rental income and total portfolio debt
- A property management metric comparing maintenance costs to rent
Correct answer: The ratio of monthly debt payments to gross monthly income, used by lenders to qualify buyers
DTI is a key underwriting metric: lenders use it to determine how much additional debt a borrower can safely carry based on their income.
Question 3: What does LTV (Loan-to-Value ratio) indicate in a mortgage context?
- The ratio of rental income to total loan balance
- The percentage of the property's value that is financed by the mortgage (Correct answer)
- The investor's equity as a percentage of total portfolio value
- The relationship between the loan term and property value over time
Correct answer: The percentage of the property's value that is financed by the mortgage
LTV = Loan Amount / Appraised Value; a lower LTV means more equity, which reduces lender risk and can result in better interest rates and no PMI.
Question 4: What is the primary risk of negative amortization in an adjustable-rate mortgage?
- The interest rate cannot adjust downward
- The loan balance can increase over time because payments don't cover all accrued interest (Correct answer)
- The borrower loses the right to prepay the loan without penalty
- Property taxes increase automatically with the loan balance
Correct answer: The loan balance can increase over time because payments don't cover all accrued interest
Negative amortization occurs when minimum payments are less than interest due, causing unpaid interest to be added to the principal, increasing the total debt owed.
Question 5: For investment property, what is typically the minimum down payment required by conventional lenders in the US?
- 3.5% (same as FHA)
- 15%–25% depending on the number of units (Correct answer)
- 5% regardless of property type
- 10% for all single-family rentals
Correct answer: 15%–25% depending on the number of units
Conventional lenders typically require 15% down for single-family investment properties and up to 25% for multi-unit (2-4 unit) investment properties.
Question 6: What is a gross rent multiplier (GRM) and how is it used?
- A ratio comparing annual operating expenses to gross rents for property management
- A quick valuation metric calculated by dividing a property's price by its annual gross rental income (Correct answer)
- A formula for estimating capital gains upon sale of a rental property
- A standard government index for residential rental rates
Correct answer: A quick valuation metric calculated by dividing a property's price by its annual gross rental income
GRM = Purchase Price / Annual Gross Rent; it's a fast screening tool to compare investment properties, though it doesn't account for expenses.
CRS Investment Analysis and Financial Concepts 2
What is a 1031 exchange and what is its primary benefit for real estate investors?