Question

You can buy the City Select building for $20,000,000 that has fixed leases in place for the next 5 years providing a constant NOI of $1,300,000. You can get a partially amortizing loan (25- year amortization period) at 4.5% with 1 point. Five years from now you expect to sell this building for a net sales price of $22,000,000. Compute the BTIRR with no loan and with a 75% LTV loan. Does this building demonstrate positive leverage? What investment conditions must be available for positive leverage?

Answer 1

BTIRR with no loan= 8.1979% as follows:

With Loan:

With LTV of 75%, loan amount= $20,000,000*75%= $15,000,000

Discount point at 1 point= $15,000,000*1% = $150,000

Down payment= $20,000,000- $15,000,000 = $5,000,000

Total initial outlay= $5,000,000 +$150,000= $5,150,000

Yearly payments= $ 1,011,585.42

Amount needed to pay off the loan after 5 years (PV of future installments)= $13,158,638.87

Calculations as follows:

Net yearly cash flow= NOI-Loan payments= 1,300,000-1,011,585.42= $288,414.58

Net terminal cash flow after 5 years= Sale price- loan pay off

= 22,000,000-13,158,638.87 = $ 8,841,361.13

BTIRR with loan= 16.0189% as follows:

This project demonstrates positive leverage.

A positive leverage takes place when investment is made with borrowed fund and the net return is higher than the cost of borrowing.