Question

acme bank is making a commercial real estate loan to jackson apartments with the following data purchase price 20 million, loan to value ratio of 75%, minimum debt service coverage 1.1 times, interest rate of 5%, cap rate of 7% and 30 year amortization. which of the following statements are false? a) cash on cash return in year one is 6.67% b) loan yield is 9.33% c) debt coverage ratio is 1.45 times

Answer 1

Answer:-

The Option c is wrong whereas the a and b are correct.

Given
purchase price = Value = 20 million
loan to value ratio = 75%
minimum debt service coverage = 1.1 times
interest rate = 5%
cap rate = 7%
30 year amortization

Loan amount / Appraisal value = LTV
Loan amount / 20 million = 75 %
Loan amount = 20 million x 0.75 = 15 million

Net Operating Income (NOI)

Value = NOI (year 1)/ Cap rate
NOI = Value x Cap rate
NOI = 20 million x 7 %
NOI = 20 million x 0.07
NOI (year 1) = 1.4 million

a) Cash-on-cash return = NOI (year 1) / Total cash invested
= 1.4 million / 20 millions
= 0.07
= 7 % ~ 6.67%
This is close to 6.67 % hence True

b) Loan yield

Loan yield = NOI / Loan amount = 1.4 million / 15 million = 0.0933 = 9.33 %
This statement is True

c) Debt coverage ratio
Debt service payment = NOI (year 1) / minimum debt service coverage ratio
= 1.4 million / 1.1
= 1.27 million
The corresponding loan amount = 1.27 million / interest rate = 1.27 million / 0.05 = 25.4 million

The maximum loan amount = 15 million ( lower of the two amounts among 15 million and 25.4 million)
At 15 million the LTV is 15 million / 20 million = 75 %

Debt coverage ratio = NOI ( year 1) / debt service
= 1.4 million / 1.27
= 1.1

Hence c is false as debt coverage ratio is 1.1 but not 1.45