Chap 017

Chapter 17
Investing in Real Estate and Other Investment Alternatives
True/False Questions
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1. In direct real estate investment, the investor holds legal title to the property.
Answer: True Difficulty: Med LO: 1 Page: 558

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2. In indirect real estate investment, the investors appoint a trustee to hold legal title on behalf of all
the investors in the group.

T
3. Limited partnerships and syndicates are examples of direct real estate investment.
Answer: False Difficulty: Easy LO: 1 Page: 558

T
4. Under the current law, if you rent out a second home for 14 days or less, the income is tax-free.
Answer: True Difficulty: Easy LO: 1 Page: 560

T
5. People buy a vacation home for tax reasons.

T
6. The Tax Reform Act of 1986 adversely affects the investment potential of real estate syndicates.

T
7. A real estate syndicate provides professional management and unlimited liability for its
members.
Answer: False Difficulty: Med LO: 1 Page: 562
8.
A syndicate may only be organized as a limited partnership.

T
9. Land purchases are speculative because they involve many risks.

T
F 10. Indirect real estate investments include investing in real estate syndicates, REITs, and
participation certificates.
F 11. Ginnie Maes are not backed by the full faith and credit of the Federal Government.
F 12. Many financial institutions hesitate to make loans on second or third mortgages.
F 13. A passive activity is a business or trade in which you do not materially participate.
F 14. Passive loss is the total amount of losses from a passive activity minus the total income from the
passive activity.
F 15. Many investors buy land with the intention of subdividing it.
16.
Real estate investment trusts are government-owned real estate companies.

T
F 17. A syndicate is a temporary association of individuals or firms, organized to perform a specific

task that requires a large amount of capital.
F 18. The syndicate may be organized as a corporation, as a trust, or as a limited partnership.

F 19. Real Estate Investment Trusts (REITs) must have at least 500 shareholders.
F 20. Real Estate Investment Trusts (REITs) must distribute at least 90 percent of their net annual
earnings to shareholders.
F 21. The limited partnership is formed by a limited partner, who has unlimited liability for its debts.
F 22. The limited partnership is formed by a general partner, who has unlimited liability for its
liabilities.
F 23. A real estate syndicate provides professional management for its members.
T
F
24.
A REIT is similar to a mutual fund or an investment company, and it trades on
stock exchanges or over-the-counter.
T
F 25. There are three types of REITs: equity REITs, mortgage REITs, and hybrid REITs.
F 26. Federal law requires REITs to distribute at least 10 percent of their net annual earnings to
shareholders.
F 27. Federal law require REITs to have at least 20 shareholders. No more than half the shares may be
owned by 15 or fewer people.
F 28. A participation certificate is an equity investment in a pool of mortgages that have been
purchased by one of the government agencies.
F 29. Since first and second mortgage are risky investments, these provide relatively high rates of
return.
F 30. One needs at least $25,000 to invest in participation certificates.

F 31. Maes and Macs are guaranteed by agencies closely tied to the federal government, making them
just as secure as Uncle Sam's own bonds and notes.
T
F
32.
Thanks to Maes and Macs mutual funds, you now need as little as $1,000 to buy
shares in a unit trust or a mutual fund whose portfolio consists entirely of these securities.
T
F 33. If you want a risk-proof real estate investment, participation certificates (PCs) are for you.
F 34. Real estate is an asset that is generally a good hedge against inflation.
F 35. The Tax Reform Act of 1986 has increased the appeal of investing in real estate.
F 36. Direct real estate investments include single family dwellings, duplexes, apartments, land, and
commercial property.
Answer: True Difficulty: Hard LO: 1 Page: 558
F 37. REITs, mortgages, and pools are examples of indirect real estate investments.
F 38. Housing will continue to be a not-so-liquid investment that promises steady returns over time.
F 39. If you own a vacation home, the after-tax cost of owing it has decreased since 1987.
40.
The primary reason you buy a vacation home is because you want to use it.

T
F 41. Commercial property refers to land and buildings that produce lease or rental income.
F 42. Investment in land usually produces considerable cash flow.

F 43. Indirect real estate investments include investing in real estate syndicates, REITs, and
participation certificates.
F 44. A REIT is a firm that pools investor funds and invests them in real estate or uses them to make
construction or mortgage loans.
F 45. A REIT must invest all of its assets in Real estate.

F 46. A REIT may engage in speculative, short-term holding of real estate to sell for quick profits.
F 47. Real Estate Operating Companies, or REOCs, are a new variation of REITs.
T
certificates.
48.
If you want a risk-proof real estate investment, you should invest in participation

T
F 49. Maes and Macs are not guaranteed by agencies closely tied to the federal government.
F 50. Real property equity investments usually do not provide protection against purchasing power
risk.
F 51. You gain entry to a shopping center investment by investing as little as $5,000 in a limited
partnership.
F 52. If you are a limited partner, you are liable for losses beyond your initial investment.
F 53. Your investment in a limited partnership does not absolve you from maintenance chores and
other administrative duties.
F 54. Financial leverage is the use of borrowed funds for investment purposes.
F 55. A limited partner's liability is restricted by the amount of his or her investment.
56.
A limited partner cannot take part in the management of the partnership.

T
F 57. General partners in a real estate partnership must bear all financial risks.
F 58. Financial leverage is a disadvantage when property values and incomes are rising.
Answer: False Difficulty: Hard LO: 2 Page: 566
F 59. Financial leverage enables you to acquire a more expensive property than you could on your
own.
F 60. Real estate investments have no disadvantages.

F 61. Perhaps the largest drawback of direct real estate investments is the absence of large, liquid, and
relatively efficient markets for them.
F 62. Under the Tax Reform Act of 1986, the long-standing favored tax treatment afforded long-term
capital gains is fully preserved.
F 63. You can sell stocks and bonds in a few minutes at the market price, but this is not a case for real
estate.
64.
It takes just a few days to sell your limited partnership shares.

T
F 65. Diversification in direct real estate investment is difficult because of the large size of most real
estate projects.
F 66. It may take months to sell commercial property on limited partnership shares.
F 67. During deflationary or recessionary periods, the values of real estate investments generally
increase.
F 68. Diversification in direct real estate investments is quite easy because of the large size of most
real estate projects.
F 69. REITs, Ginnie Maes, Freddie Macs, and syndicates do not provide any diversification.
F 70. The tax shelter aspect of real estate syndicates no longer exists.
F 71. Now real estate investors must use accelerated depreciation methods to recover the costs.
72.
Real estate investors must use the straight-line depreciation method.

T
F 73. The tax laws do not allow real restate investors to take losses in excess of the actual amounts
they invest.
F 74. Gold prices tend to go down by such factors as fear of war, political instability, and inflation.
F 75. Low interest rates in the economy depress gold prices.

F 76. High interest rates depress gold prices because they make it very expensive to carry gold as an
investment.
F 77. You can avoid storage and assaying problems by investing in gold bullion coins.
F 78. Diamonds and other precious stones can easily be turned into cash.
F 79. Scams in collectibles have increased recently.

F 80. Collecting for investment purposes is very similar to collecting as a hobby.

10
81.
You can sell collectibles at the right price on short notice.

T
F 82. Collectibles may be difficult to sell at the right price on short notice.
F 83. Easing of international tensions or disinflation causes a decline in gold prices.

F 84. Low interest rates depress gold prices.

F 85. Gold prices are subject to daily price fluctuations.

F 86. The basic unit of gold bullion is one troy ounce.

F 87. On small gold bars, gold dealers and banks add a five to eight percent premium over the pure
gold bullion value.
F 88. Gold bullion poses storage problems.

F 89. The first gold bullion coin ever produced by the U. S. government was issued in 2001.
11
T
F
least two percent.
90.
Most brokers require a minimum order of ten coins and charge a commission of at

T
F 91. You may invest in gold by purchasing the common stocks of gold mining companies.
F 92. Investments in silver, platinum, palladium, and rhodium are not used as a hedge against inflation.
F 93. Unlike stocks and bonds, precious metals sit in vaults earning nothing.
F 94. When you purchase precious stones, it is difficult to determine whether you are getting a good
stone.
F 95. Grading of diamonds is an exact science.

F 96. Collectibles include rare coins, works of art, antiques, stamps, rare books, paintings, and other
items that appeal to collectors and investors.
F 97. The world of collectibles is expanding onto the Web at a geometric rate.
12
T
F
98.
armoires and vintage cars.
Collectibles dealers say the Net is best suited to large items such as antique

T
F 99. Prices of collectibles aren't necessarily cheaper on the Web, but it's much easier to compare them.
F 100. Virtual collecting has no drawbacks.

Multiple Choice Questions

101. Real estate investments are classified as
A) speculative or nonspeculative.
B) common or preferred.
C) cumulative or noncumulative.
D) direct or indirect.
E) participating or nonparticipating.
Answer: D Difficulty: Med LO: 1 Page: 558
102. An example of an indirect real estate investment is a(n)
A) single family dwelling.
B) duplex.
C) apartment.
D) land.
E) participation certificate.
Answer: E Difficulty: Med LO: 1 Page: 558
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103. An example of a direct real estate investment is a

A) limited partnership.
B) real estate dwelling.
C) real estate syndicate.
D) real estate investment trust.
E) mortgage pool.
Answer: B Difficulty: Med LO: 1 Page: 558
104. Over time, the prices of single-family houses
A) tend to rise.
B) rise less than the Consumer Price Index.
C) remain stable in the northern parts of the United States.
D) rise in New England states, but decline in the South.
E) remain unchanged in the United States.
Answer: A Difficulty: Med LO: 1 Page: 558
105. If you have a vacation home, the after-tax cost of owning it in recent years has
A) risen.
B) remained unchanged.
C) declined.
D) declined, but only if you own stocks.
E) declined, but only if you own tax-exempt bonds.
106. Aside from a home, the real property investment most widely favored by the small investor is
A) a post office building.
B) land.
C) a building with 20 apartments.
D) a condominium.
E) the duplex, four-plex, or small apartment building.
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107. Which type of REIT invests directly in properties?

A) compound REIT
B) equity REIT
C) mortgage REIT
D) hybrid REIT
E) simple REIT
108. Which type of REIT pools money to finance construction loans?
A) mortgage REIT
B) compound REIT
C) hybrid REIT
D) simple REIT
E) equity REIT
109. Federal law requires REITs to
A) distribute at least 90 percent of their earnings to shareholders.
B) engage in short-term holdings of real estate.
C) register with the U.S. Department of Housing & Urban Development.
D) reinvest at least 50 percent of their income in rental properties.
E) have at least 500 shareholders.
110. If you want a risk-proof real estate investment, invest in
A) real estate investment trusts.
B) real estate limited partnerships.
C) participation certificates (PCs. .
D) real estate syndicates.
E) post office buildings.
Answer: C Difficulty: Hard LO: 1 Page: 564
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111. In what type of real estate investment does the investor holds legal title to the property?
A) Ginnie Mae
B) participation certificates (PCs.
C) real estate investment trusts (REITs.
D) direct investment
E) indirect investment
Answer: D Difficulty: Hard LO: 1 Page: 558
112. An example of an indirect real estate investment is
A) a single-family home.
B) a duplex.
C) a real estate investment trust (REIT. .
D) land.
E) an apartment building.
Answer: C Difficulty: Hard LO: 1 Page: 559
113. Real property equity investments are usually considered attractive during times of
A) deflation.
B) disinflation.
C) inflation.
D) recession.
E) unemployment.
Answer: C Difficulty: Med LO: 2 Page: 564
114. One of the advantages of being a limited partner in a real estate investment venture is that you have
____________ liability.
A) no financial
B) unlimited financial
C) product
D) limited financial
E) implied
16
115. General partners in a real estate investment venture have ____________ liability.
A) no financial
B) unlimited financial
C) limited financial
D) express
E) implied
Answer: B Difficulty: Easy LO: 2 Page: 565
116. One of the advantages of investing in limited partnerships, REITs, mortgages, or participation
certificates is that you do not need to worry about
A) federal income taxes.
B) state income taxes.
C) capital gains taxes.
D) declining property taxes.
E) maintenance chores.
Answer: E Difficulty: Hard LO: 2 Page: 565
117. Financial leverage refers to
A) the use of borrowed funds for investment purposes.
B) the mathematical law of large numbers.
C) financial averages.
D) buying and selling short.
118. One of the possible advantages of investing in a real estate limited partnership is that you
A) don't have to worry about capital gains tax.
B) don't have to pay federal income tax.
C) don't have to pay state income tax.
D) gain entry to a shopping center or large building by investing as little as $5,000.
17
119. One of the disadvantages of investing in real estate is that

A) it provides a hedge during inflation.
B) you have unlimited financial liability.
C) you have limited financial liability.
D) it provides financial leverage.
E) during deflationary periods, the value of such investments may decline.
120. Deflation in commercial real estate began sporadically in the
A) late 1980s.
B) early 1980s.
C) late 1970s.
D) early 1970s.
E) early 1960s.
121. Perhaps the largest drawback of direct real estate investments is
A) a hedge during rising prices.
B) early entry.
C) the absence of large and liquid markets for them.
D) financial leverage.
122. Illiquidity in real estate means that
A) you can quickly sell the property.
B) you don't have a water well on the property.
C) you cannot quickly sell the property.
D) you don't have financial leverage.
E) there is an efficient market for the property.
18
123. Diversification in direct real estate investments is

A) difficult.
B) easy.
C) a drawback.
D) impossible.
E) foolhardy.
Answer: A Difficulty: Easy LO: 3 Page: 566
124. Which one of the following real-estate investments provides some diversification?
A) a single-family dwelling
B) an apartment building
C) raw land
D) a second mortgage
E) a real estate investment trust (REIT.
125. REITs, Ginnie Maes, and Freddie Macs are examples of ____________ real estate investments.
A) direct
B) indirect
C) safe
D) risky
E) speculative
126. Which one of the following investments in real estate does not provide diversification?
A) REITs
B) Ginnie Maes
C) Freddie Macs
D) land
E) PCs
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127. The tax shelter aspect of a real estate syndicate

A) no longer exists.
B) is strengthened by the Tax Reform Act of 1986.
C) has remained unchanged since 1986.
D) will return in 2005.
E) is available only to doctors.
128. Now you are required to use which method of depreciation in real estate investments?
A) sum-of-the-digits
B) straight-line
C) the rule of 78s
D) Last In First Out (LIFO.)
E) First in First Out (FIFO. )
Answer: B Difficulty: Hard LO: 3 Page: 567
129. For residential real estate investments, the depreciation period now is ____________ years.
A) 7 1/2
B) 17 1/2
C) 20 1/2
D) 27 1/2
E) 31 1/2
130. For all other types of real estate investments (except residential real estate), the depreciation period now
is ____________ years.
A) 7 1/2
B) 17 1/2
C) 20 1/2
D) 27 1/2
E) 31 1/2
20
131. Investment tax credit is eliminated entirely for all types of real estate except
A) low income housing projects.
B) single family dwellings.
C) shopping centers.
D) raw land.
E) developed land.
Answer: A Difficulty: Hard LO: 3 Page: 567
132. The Tax Reform Act of 1986 dictates that for commercial property, the following depreciation method
must be used:
A) sum-of-the-digits.
B) straight line.
C) declining balance.
D) the rule of 78s.
133. Which of the following is a possible disadvantage of real estate investments?
A) financial leverage
B) hedge against inflation
C) illiquidity
D) easy entry
E) limited financial liability
134. Which one of the following is a possible disadvantage of real estate investments?
A) financial leverage
B) hedge against inflation
C) easy entry
D) short period of depreciation
E) long period of depreciation
21
135. When is the price of a precious metal, such as gold, silver or platinum, likely to increase?
A) during recession
B) during depression
C) during peace time
D) during war time
E) during inflation
136. Investors buy precious metals as a hedge against
A) recession.
B) depression.
C) inflation.
D) deflation
Answer: C Difficulty: Easy LO: 4 Page: 567
137. Easing of international tensions or disinflation causes gold price to
A) skyrocket.
B) increase moderately.
C) remain stable.
D) decline.
138. High prevailing interest rates in the economy cause gold prices to
A) skyrocket.
B) increase moderately.
C) remain stable.
D) decline.
139. In general, the price of gold
A) stays stable.
B) fluctuates daily.
C) changes monthly.
D) is not affected by political upheavals.
E) manipulated by Swiss gold dealers.
22
140. The basic unit of gold bullion is one

A) kilogram.
B) troy ounce.
C) pound.
D) ton.
E) wafer.
141. On small gold bars, dealers and banks add ____________ percent premium over the pure gold bullion
value.
A) 1 to 2
B) 3 to 5
C) 5 to 8
D) 9 to 12
142. You can avoid storage and assaying problems by investing in
A) gold.
B) gold wafers.
C) gold bars.
D) gold bullion.
E) gold bullion coins.
Essay Questions
143. What are direct and indirect investments in real estate? Give examples.
Difficulty: Med LO: 1 Page: 558-564
Answer:
Real estate investments are classified as direct or indirect. Direct real estate investments, in which the
investor holds legal title to the property, include a home, a vacation home, commercial property, and raw
land. Indirect real estate investments include real estate syndicates, REITs, mortgages, and participation
certificates.
23
144.
What are possible advantages of real estate investments?

Answer:
Real estate investments may have these advantages: a hedge against inflation, easy entry, limited
financial liability, no management headaches, and financial leverage.
145. What are possible disadvantages of real estate investments?
Answer:
Real estate investments may have these disadvantages: declining values, illiquidity, lack of
diversification, and the reduction or elimination of tax advantages.
146. What are the risks and rewards of investing in precious metals, gems, and collectibles?
Answer:
Some investors prefer to invest in precious metals, such as gold, platinum, and silver; precious stones,
such as diamonds; or collectibles, such as stamps, rare coins, works of art, antiques, rare books, and
Chinese ceramics. Collectibles do not provide current income, and they may be difficult to sell in a
hurry. But, precious metals, gems, and collectibles may provide a hedge against inflation.
24

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Chapter 17

Investing in Real Estate and Other Investment Alternatives

Answer: True Difficulty: Med LO: 1 Page: 558

Answer: True Difficulty: Med LO: 1 Page: 558

Answer: False Difficulty: Easy LO: 1 Page: 558

Answer: True Difficulty: Easy LO: 1 Page: 560

5. People buy a vacation home for tax reasons.

Answer: False Difficulty: Easy LO: 1 Page: 560

Answer: True Difficulty: Med LO: 1 Page: 562

Answer: False Difficulty: Med LO: 1 Page: 562

A syndicate may only be organized as a limited partnership.

Answer: False Difficulty: Easy LO: 1 Page: 562

9. Land purchases are speculative because they involve many risks.

Answer: True Difficulty: Easy LO: 1 Page: 561

Real estate investment trusts are government-owned real estate companies.

Answer: False Difficulty: Med LO: 1 Page: 562

F 17. A syndicate is a temporary association of individuals or firms, organized to perform a specific

F 18. The syndicate may be organized as a corporation, as a trust, or as a limited partnership.

F 30. One needs at least $25,000 to invest in participation certificates.

Answer: True Difficulty: Easy LO: 1 Page: 560

F 42. Investment in land usually produces considerable cash flow.

F 45. A REIT must invest all of its assets in Real estate.

Answer: True Difficulty: Med LO: 1 Page: 564

A limited partner cannot take part in the management of the partnership.

Answer: True Difficulty: Hard LO: 2 Page: 565

F 60. Real estate investments have no disadvantages.

It takes just a few days to sell your limited partnership shares.

Answer: False Difficulty: Easy LO: 3 Page: 566

Real estate investors must use the straight-line depreciation method.

Answer: True Difficulty: Med LO: 3 Page: 567

F 75. Low interest rates in the economy depress gold prices.

F 79. Scams in collectibles have increased recently.

F 80. Collecting for investment purposes is very similar to collecting as a hobby.

You can sell collectibles at the right price on short notice.

Answer: False Difficulty: Easy LO: 4 Page: 573

F 83. Easing of international tensions or disinflation causes a decline in gold prices.

F 84. Low interest rates depress gold prices.

F 85. Gold prices are subject to daily price fluctuations.

F 86. The basic unit of gold bullion is one troy ounce.

F 88. Gold bullion poses storage problems.

Answer: True Difficulty: Hard LO: 4 Page: 568

F 95. Grading of diamonds is an exact science.

Answer: False Difficulty: Hard LO: 4 Page: 571

F 100. Virtual collecting has no drawbacks.

Multiple Choice Questions

103. An example of a direct real estate investment is a

107. Which type of REIT invests directly in properties?

119. One of the disadvantages of investing in real estate is that

123. Diversification in direct real estate investments is

127. The tax shelter aspect of a real estate syndicate

140. The basic unit of gold bullion is one

What are possible advantages of real estate investments?

Difficulty: Med LO: 2 Page: 564-566

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