CHAPTER 13

Risk Analysis

TRUE/FALSE

1. Partitioning the internal rate of return is useful because it helps the investor to determine
how much of the return is from annual operating cash flow and how much is from the
projected resale cash flow. (T)

2. In general, investors risk seekers and, therefore, must be compensated more for the higher
risk of some investments. (F)

3. Financial risk increases as the amount of debt increases. (T)

4. Real estate that is not leveraged does not have interest rate risk. (F)

5. Real estate has a lot of inflation risk. (F)

6. Use of leverage always increases the amount of risk. (T)

7. The range of returns (highest to lowest) is the most common risk measure. (F)

8. The term “due diligence” refers to doing an investigation before buying a property. (T)

9. Land can be viewed as having an “option” to develop the land. (T)

10. Percentage rent is common in office building leases. (F)

11. The term “financial risk” refers to the probability of interest rates changing. (F)

12. In general, real estate is usually considered more risky than bonds but less risky than
stocks. (T)

13. A property with a higher standard deviation and a higher return is preferable to a property
with a lower standard deviation and a lower return. (F)

MULTIPLE CHOICE

-1-
 16%

14%
D

12%

10%
B C
Return

8%
A
6%

4%

2%

0%
- 0.01 0.02 0.03 0.04 0.05 0.06 0.07 0.08 0.09
Standard Deviation

14. Consider risk-return characteristics of Investments A-D, given above. Which of the following
statements is TRUE? (D)

(A) Investment A is preferred over all other investments

(B) Investment D is preferred over all other investments
(C) Investment A is preferred to Investment B
(D) Investment B is preferred to Investment C
(E) Investment C is preferred to Investment D

15. Consider two investments:

Investment 1 has a 50% chance of producing a return of zero and a 50% chance of
producing a return of 40%

Investment 2 has a 50% chance of producing a return of 10% and a 50% chance of
producing a return of 30%

Which of the following statements regarding the investments is TRUE? (A)

(A) Investment 1 is riskier than Investment 2

(B) Investment 2 is riskier than Investment 3
(C) Investment 1 and Investment 2 have the same amount of risk
(D) Investment 1 is a better investment because it has the potential to produce the highest
returns

-2-
16. Which of the following is NOT a component of lease rollover risk? (C)

(A) Commissions paid to a leasing agent to find a new tenant

(B) Costs of tenant improvements demanded by new tenants
(C) Liquidity risk
(D) Reduced revenues from vacancy until a new tenant is found

17. Consider an investment in which a developer plans to begin construction of a building one
year if, at that point, rent levels make construction feasible and the building will cost
$1 million to construct. There is a 50 percent chance that NOI will be $160,000 and a
50 percent chance that NOI will be $80,000. Using the traditional approach, similar to the
“highest and best use” approach, what would be the land value of the property assuming a
cap rate of 10 percent (12 percent discount rate and an NOI growth rate of 2 percent)? (B)

(A) $120,000
(B) $200,000
(C) $300,000
(D) $833,333
(E) $1,000,000

18. Using the same information as the question above, what would the land value be under the
real options approach? (C)

(A) $120,000
(B) $200,000
(C) $300,000
(D) $833,333
(E) $1,000,000

19. Risk due to potential tax law changes is referred to as: (C)

(A) Business risk

(B) Financial risk
(C) Legislative risk
(D) Tax risk

20. When an investor performs an investigation while considering acquisition of a property, this
is referred to as: (C)

(A) Investigation
(B) Risk analysis
(C) Due diligence
(D) Acquisition analysis

21. Which of the following refers to the risk real estate investors face stemming from changes in
general economic conditions? (D)

(A) Financial risk

(B) Liquidity risk
(C) Environmental risk
(D) Business risk

-3-
22. Which of the following BEST describes the process of “partitioning the IRR”? (B)

(A) Dividing the IRR into income and appreciation components

(B) Using the IRR as a discount rate and determining how much of the present value comes
from income and resale
(C) Dividing the IRR into before-tax and after-tax IRRs
(D) Determining how much of the IRR comes from each property in a portfolio

23. When sales exceed a breakpoint sales volume in a retail lease with percentage rent, the
additional rent is referred to as: (C)

(A) Retail rent

(B) Participation rent
(C) Overage rent
(D) Sales rent

24. Renewal probabilities related to a lease renewal can affect which of the following? (D)

(A) Market rent paid after the existing lease ends

(B) Vacancy after the existing lease ends.
(C) Leasing commissions paid after the existing lease ends
(D) All of the above

25. The renewal probability is assumed to be 60% for a particular lease with 12 months vacant if
the lease is not renewed. The expected vacancy at the end of the lease is: (A)

(A) 4.8 months

(B) 7.2 months
(C) 9.0 months
(D) 12.0 months

26. Which of the following best describes valuing land as a “real option”? (A)

(A) The land value reflects the fact that the developer can wait to decide whether to
construct a building on the site
(B) The seller provides the investor with an option to purchase the land at a specific price
before a certain date
(C) The land is valued at its most probable use
(D) The seller has an option to repurchase the land from the buyer before construction takes
place

27. Which of the following is an example of real options? (D)

(A) Valuation of vacant land

(B) Valuation of projects with phases of development
(C) Valuation of a building that can be renovated
(D) All of the above

-4-
28. An investor is analyzing the risk of a possible investment by producing three different
scenarios. Under a pessimistic scenario, the property would produce a BTIRRp of 8%; a
most-likely scenario produces a BTIRRp of 12%. The investor assigns the pessimistic
scenario a 25% chance of occurring, the most-likely case a 60% chance of occurring, and
the optimistic scenario a 15% chance of occurring. What is the standard deviation of the
returns? (C)

(A) 0.01249
(B) 0.0090
(C) 0.000156
(D) 0.0949

-5-