REA Financial Modeling & Investment Analysis 3 — Questions and Answers
Question 1: A developer underwrites a mixed-use project with a stabilized NOI of $900,000 and a 6% market cap rate. If total project cost is $16,000,000, what is the development spread?
- −37.5 bps
- +62.5 bps
- +37.5 bps (Correct answer)
- +150 bps
Correct answer: +37.5 bps
Yield on cost = $900,000 / $16,000,000 = 5.625%; development spread vs. 6% cap rate = −37.5 bps, indicating the project destroys value at current costs.
Question 2: Which metric measures the annual return on total asset value regardless of financing?
- Cash-on-cash return
- Capitalization rate (Correct answer)
- Equity dividend rate
- Debt yield
Correct answer: Capitalization rate
The capitalization rate measures NOI as a percentage of asset value and is unaffected by financing structure.
Question 3: In a joint venture waterfall, a 'catch-up' provision typically allows the:
- LP to recoup all capital before the GP earns any profits
- GP to receive a disproportionate share of profits until reaching its target promote (Correct answer)
- LP to increase its preferred return after a hurdle is missed
- Lender to participate in upside above the debt yield threshold
Correct answer: GP to receive a disproportionate share of profits until reaching its target promote
A catch-up clause lets the GP receive the majority of distributions until it has been paid its cumulative promote percentage.
Question 4: Straight-line rent averaging is most commonly used when underwriting:
- Multifamily properties with month-to-month tenants
- Office leases with free rent and scheduled rent steps (Correct answer)
- Land under a ground lease
- Self-storage facilities
Correct answer: Office leases with free rent and scheduled rent steps
GAAP straight-line rent averaging smooths free rent periods and scheduled increases over the full lease term, most applicable to long-term commercial leases.
Question 5: What is the primary purpose of a ground lease in real estate financial modeling?
- To eliminate depreciation recapture at sale
- To separate land ownership from improvements and generate a ground rent obligation (Correct answer)
- To allow 100% LTV financing on the land component
- To convert a fee-simple interest into a leasehold for tax benefits
Correct answer: To separate land ownership from improvements and generate a ground rent obligation
A ground lease separates land and building ownership, with the lessee paying ground rent and owning only the leasehold improvements.
Question 6: If a property's NOI grows at 3% annually and the terminal cap rate equals the going-in cap rate, how does the exit price change?
- It stays the same as the purchase price
- It decreases by 3% annually
- It increases at the same 3% annual rate as NOI (Correct answer)
- It increases by less than 3% due to cap rate expansion
Correct answer: It increases at the same 3% annual rate as NOI
When terminal cap rate equals going-in cap rate, exit value = terminal NOI / cap rate, growing exactly in line with NOI growth.
Question 7: A real estate analyst calculates a property's break-even occupancy at 72%. Current occupancy is 85%. This 13-point cushion is best described as:
- Debt service coverage margin
- Occupancy buffer or downside cushion (Correct answer)
- Economic vacancy allowance
- Lease-up stabilization period
Correct answer: Occupancy buffer or downside cushion
The gap between current occupancy and break-even occupancy represents the downside cushion before debt service is jeopardized.
REA Financial Modeling & Investment Analysis 3
A developer underwrites a mixed-use project with a stabilized NOI of $900,000 and a 6% market cap rate.
If total project cost is $16,000,000, what is the development spread?