Free CFA Level III: Private Markets Private Real Estate Practice Questions

C is correct.

NOI = Gross rental income + Other income - Vacancy/credit losses - Operating expenses (property taxes, insurance, repairs, maintenance, management fees, utilities). NOI excludes debt service (mortgage payments), capital expenditures, and income taxes because it represents the property's operating performance independent of its financing structure and owner's tax situation.

C is correct. Because the mortgage is interest only, annual debt service is the coupon on the full balance:
$$DS = \$45{,}000{,}000 \times 0.0520 = \$2{,}340{,}000$$
The equity the account contributes at closing is the purchase price less the loan:
$$E = \$80{,}000{,}000 - \$45{,}000{,}000 = \$35{,}000{,}000$$
First-year before-tax cash flow to equity is stabilized NOI less debt service:
$$\$5{,}000{,}000 - \$2{,}340{,}000 = \$2{,}660{,}000$$
The equity dividend rate is that cash flow divided by the equity invested:
$$\frac{\$2{,}660{,}000}{\$35{,}000{,}000} = 0.0760 = 7.6\%$$
The unlevered going-in yield is $\$5{,}000{,}000/\$80{,}000{,}000 = 6.25\%$, which exceeds the 5.20% borrowing rate, so the mortgage is accretive to the first-year cash return, lifting it from 6.25% to 7.6%. The trustee should also be told that the same leverage magnifies downside outcomes: the debt service is fixed while NOI is not.

A is correct. A buyer at the end of year 5 pays for the income stream that begins the following year, so the reversion is estimated by capitalizing the year 6 projected NOI of $5,800,000 at the terminal rate of 6.50%:
$$V_5 = \frac{\$5{,}800{,}000}{0.0650} = \$89{,}230{,}769$$
Selling costs of 2.0% of the gross sale price are then deducted:
$$\$89{,}230{,}769 \times (1 - 0.020) = \$87{,}446{,}154$$
or approximately $87.4 million. Repaying the unamortized $45,000,000 balance would leave about $42.4 million of equity reversion, but the trustee asked for proceeds before debt repayment. Note that the 6.50% terminal rate is 50 basis points above the 6.00% rate extracted from the Bellhaven sale, a conservative allowance for the building being five years older and the leases five years shorter at the time of sale; each 25 basis point increase in the exit rate would reduce the gross reversion by roughly $3.3 million.