Chapter 15 - Examining Real Property Risk
Selected end of chapter solutions and/or directions to answers:
1. There are many factors influencing the risk of an income stream, from tenant quality to
macro factors (retail sales, national employment, regulation, zoning) and factors related
to the property itself: local infrastructure, building condition, the skills of the property
manager, area crime, the entry or exit of major employers in the area, weather (rainy
summers slam outdoor cafes!), and operating costs (property taxes and insurance
premiums can change unexpectedly) are only a few of the factors impacting the risk of
the income stream deriving from a property.
2. Employment, public transportation and building access for the disabled are all addressed
by the ADA. Each is protected, provided no “unreasonable” cost is born by the employer
or building owner in complying.
3. Pass-through costs can be assessed based on square footage leased. As costs such as
property taxes or landscaping increase unexpectedly (as with irrigation costs during a
drought), they can be passed onto the tenants. Many national tenants put limits, however,
on these increases.
4. Property management is key, and includes responsibilities that vary based upon the lease;
besides tenant screening with all properties, some triple-net industrial leases include very
little duty besides record-keeping and rent collection. Residential management might
include all repairs (excepting damage caused by the tenant) and even utility provisions,
depending upon the property.
5. Undeveloped land can be used, in the interim, as a golf course, a shooting range, a
driving range, a mobile home park, a campground, an outdoor festival facility (think
Woodstock or a county fair), farming or as a parking lot. Construction of any permanent
building is not a practical interim use, excepting perhaps restroom facilities or a modest
office to support one of the uses listed.
6. Tenant selection, property care, tenant relationship management, marketing and careful
record keeping can all reduce the risks attaching to a property’s income stream.
7. Leverage enhances the positive and negative performance or any investment; leverage is
wonderful with a well-performing property; leverage can turn a modest net operating
income into a negative cash flow after debt service. If the net operating income is less
than the debt service, this negative outcome results, and the owner may wish no debt had
been used!
8. Release clauses allow master mortgages to cover a broad expanse of property or housing
development (tract houses, condos, townhouses, boat slips, etc) as it is developed, with
individual parcels “paid off” according to the terms of the mortgage and released from
the master mortgage, such that they can then be used as collateral on new purchase
mortgages by the buyers of the lots, or condominiums.
Selected chapter 15 objective practice questions:
1.
Which of the following risk characteristics of an income stream should be considered
when a comparison is made between a property with 3 years to run on its lease and one
with 14 years remaining?
(A) quality
(B) durability
(C) quantity
(D) none of these
2.
A lease that passes management and maintenance responsibility onto
the tenant is called a
(A) term lease
(B) percentage lease
(C) net lease
(D) gross lease
3.
The rental amount under a percentage lease is best calculated on the
(A) net income
(B) profit margin
(C) total inventory
(D) gross sales
4.
The operation of an income property involves all of the following EXCEPT
(A) the efficient design of the building itself
(B) maintenance of the premises
(C) securing and screening tenants
(D) supervision of operating personnel
5.
The term “inventory property” as used by the IRS means
(A) anything stored on the property
(B) warehouse property
(C) property held for resale to others
(D) stored property that is not sold
6.
All of the following are practical methods of deriving income from undeveloped land
while holding it for future sale EXCEPT
(A) using it for recreational facilities
(B) converting it to a parking lot
(C) using it as a mobile home park
(D) building small single family houses