Investment (Property) 2 — Questions and Answers
Question 1: What does the term 'leverage' mean in real estate investing?
- Using borrowed money to increase potential return (Correct answer)
- Buying property only with cash
- Selling at a loss for tax benefits
- Renting to family members
Correct answer: Using borrowed money to increase potential return
Leverage uses borrowed capital, such as a mortgage, to amplify potential returns on invested equity.
Question 2: Which metric measures annual rental income relative to property purchase price?
- Gross rental yield (Correct answer)
- Loan-to-value ratio
- Debt service coverage
- Capital gains rate
Correct answer: Gross rental yield
Gross rental yield divides annual rent by purchase price to show income return.
Question 3: What is a capitalization rate (cap rate) used to evaluate?
- A property's rate of return based on net operating income (Correct answer)
- The interest rate on a mortgage
- The annual property tax owed
- The depreciation schedule length
Correct answer: A property's rate of return based on net operating income
Cap rate equals net operating income divided by property value, indicating return independent of financing.
Question 4: Which expense is typically NOT included in net operating income calculations?
- Mortgage principal and interest payments (Correct answer)
- Property taxes
- Insurance premiums
- Maintenance costs
Correct answer: Mortgage principal and interest payments
NOI excludes debt service, so mortgage payments are not subtracted when calculating it.
Question 5: What does a 1031 exchange allow a U.S. real estate investor to do?
- Defer capital gains taxes by reinvesting in a like-kind property (Correct answer)
- Avoid all property taxes permanently
- Convert a rental to a primary residence tax-free
- Eliminate mortgage interest
Correct answer: Defer capital gains taxes by reinvesting in a like-kind property
A 1031 exchange defers capital gains tax when proceeds are reinvested into a like-kind property.
Question 6: What is 'positive cash flow' in a rental property investment?
- Rental income exceeds all operating expenses and debt payments (Correct answer)
- The property has appreciated in value
- The mortgage is fully paid off
- Tenants pay rent on time
Correct answer: Rental income exceeds all operating expenses and debt payments
Positive cash flow means income left over after paying all expenses and the mortgage.
Question 7: Which is a primary advantage of investing in a REIT over direct property ownership?
- Greater liquidity since shares trade on exchanges (Correct answer)
- Guaranteed appreciation
- No exposure to market risk
- Direct control over individual buildings
Correct answer: Greater liquidity since shares trade on exchanges
REIT shares trade like stocks, offering far more liquidity than physical real estate.
Investment (Property) 2
What does the term 'leverage' mean in real estate investing?