Question

Suppose a real estate investor owns several real estate investments, each purchased at "informationally efficient" prices (i.e., where all relevant information about the assets is known prior to purchase for this tax cohort. In other words, where each investment was purchased with a zero net present value).

a) What is the impact on the investor of adding another real estate investment also with a net present value of zero?

b) If mortgage debt is used to purchase real estate investments, how does this decision make investors better off? Explain.

c) Should investor finance the investment with all case, or with a small, medium or large mortgage? Why?

Answer 1

A) After adding investment that is having NPV of zero, the wealth of investor will remain constant. In other words, it will not bring any kind of value addition to the wealth of the investor.

B) After adding debt in investor portfolio, he can leverage his capital structure. This will help him in maximizing his return.

C) This will depend on the interest rate paying capacity and duration for which investor wants to take a loan. Investor have to pay less interest if the mortgage is high and vica-versa and investor has to pay less interest rate on long term loan and vica-versa