Question

A lender makes a 70% LTV convertible mortgage loan at a below-market rate of 6.5% on a property selling for $16,500,000. The term of the loan is 20 years; however, the lender has a conversion option at the end of the 5^th year. At the end of the 5^th year, the lender can convert their debt position into a 50% ownership stake in the property. If the property appreciates at 4.5% per year over those first five years, should the lender exercise their option?

Answer 1

Given,

Property value= $16,500,300 and LTV= 70%

Therefore, loan amount = $16,500,300*70% = $11,550,210

Yearly payments =$1,048,255.43

Balance outstanding after 5 years =$9,856,398.64

Details as follows:

With yearly appreciation of 4.5%, value of the property after 5 years= $16,500,300*(1+4.5%)^5

= $ 20,562,375.83

50% of the appreciated value= $ 20,562,375.83/2= $ 10,281,187.91

The lender will get higher amount of $ 10,281,187.91 being 50% of the value instead of the loan balance of $9,856,398.64 if the option for conversion is exercised. Hence the lender shall exercise the option.