Podcast
Questions and Answers
What is the effect of using financial leverage on risk to the equity investor?
What is the effect of using financial leverage on risk to the equity investor?
- Increases risk to the equity investor.
- Decreases risk to the equity investor. (correct)
- May increase or decrease risk to the equity investor, depending on tax treatment.
- Has no impact on risk to the equity investor.
If an investor's sole asset is being financed, how does the debt-to-equity ratio relate to the loan-to-value ratio?
If an investor's sole asset is being financed, how does the debt-to-equity ratio relate to the loan-to-value ratio?
- Less than the loan-to-value ratio.
- Greater than the loan-to-value ratio.
- Unrelated to the loan-to-value ratio.
- The same as the loan-to-value ratio. (correct)
What does the debt coverage ratio compare?
What does the debt coverage ratio compare?
- The amount borrowed and the annual debt service.
- The net operating income and the amount borrowed.
- The net operating income and the annual debt service.
- The amount borrowed and the value of the mortgaged property. (correct)
What does it indicate when the rate of return on assets exceeds the cost of borrowing?
What does it indicate when the rate of return on assets exceeds the cost of borrowing?
Which institution accounts for the greatest volume of real estate loans?
Which institution accounts for the greatest volume of real estate loans?
What happens if the NOI as a percent rate of return on assets drops below the debt service constant?
What happens if the NOI as a percent rate of return on assets drops below the debt service constant?
What is the relationship between the debt coverage ratio and net operating income?
What is the relationship between the debt coverage ratio and net operating income?
In which situation does financial leverage typically decrease risk?
In which situation does financial leverage typically decrease risk?
What effect does mortgage financing have?
What effect does mortgage financing have?
Which statement correctly describes financial leverage?
Which statement correctly describes financial leverage?
Which statement regarding debt-to-equity and loan-to-value ratios is accurate?
Which statement regarding debt-to-equity and loan-to-value ratios is accurate?
What is the correct formula for calculating the loan-to-value ratio?
What is the correct formula for calculating the loan-to-value ratio?
How does financial leverage typically affect return on equity?
How does financial leverage typically affect return on equity?
Which of the following statements about the spread is true?
Which of the following statements about the spread is true?
What is a primary consideration in choosing between debt-to-equity and loan-to-value ratios?
What is a primary consideration in choosing between debt-to-equity and loan-to-value ratios?
Flashcards
Financial leverage
Financial leverage
The difference between the rate of return on assets and the cost of borrowing.
Debt-to-equity ratio
Debt-to-equity ratio
A measure of how much debt a company uses to finance its assets.
Loan-to-value ratio
Loan-to-value ratio
A measure of how much of a property's value is financed by a mortgage.
Mortgage financing
Mortgage financing
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After-tax cash flow
After-tax cash flow
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Before-tax cash flow
Before-tax cash flow
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Income tax consequences
Income tax consequences
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Financial Leverage and Risk
Financial Leverage and Risk
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Debt-to-Equity Ratio vs. Loan-to-Value Ratio
Debt-to-Equity Ratio vs. Loan-to-Value Ratio
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Debt Coverage Ratio
Debt Coverage Ratio
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Positive Spread in Real Estate
Positive Spread in Real Estate
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Biggest Source of Real Estate Loans
Biggest Source of Real Estate Loans
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NOI vs. Debt Service Constant
NOI vs. Debt Service Constant
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Debt Service Constant
Debt Service Constant
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Interest Rate
Interest Rate
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Study Notes
Financial Leverage and Real Estate Investment
- Using financial leverage increases risk to the equity investor, not decreases it.
- It can potentially increase or decrease risk, contingent on how interest expense is handled (tax implications). It also depends on the equity investor's tax bracket.
Debt-to-Equity Ratio vs. Loan-to-Value Ratio
- If real estate is an investor's sole asset, their debt-to-equity ratio will be greater than their loan-to-value ratio.
Debt Coverage Ratio
- The debt coverage ratio compares net operating income (NOI) to annual debt service.
Rate of Return on Assets and Cost of Borrowing
- A favorable spread occurs when the rate of return on assets surpasses the cost of borrowing.
Institution Lenders in Real Estate
- Commercial banks are the largest providers of real estate loans.
NOI and Return on Equity (ROE)
- When the NOI (as a percentage of return on assets) falls below the debt service constant, using financial leverage decreases current return on equity.
Mortgage Financing Impacts
- Mortgage financing affects before-tax cash flow, income tax consequences, and after-tax cash flow. It impacts all aspects.
Spread Definition
- Spread refers to the difference between the rate of return on assets and the cost of borrowing.
Loan-to-Value Ratio (LTV) Usage
- Loan-to-value ratios are more commonly used than debt-to-equity ratios in real estate finance.
Loan-to-Value Ratio Calculation
- Loan-to-value ratio = Mortgage amount / Appraised property value
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Description
Explore the concepts of financial leverage and its impact on real estate investments. This quiz covers critical aspects such as the debt-to-equity ratio, debt coverage ratio, and the role of institutional lenders. Understand how financial leverage can both increase and decrease risks for investors.
