In: Finance
A property has an expected first-year NOI of $1 million. Recent sales of similar properties indicate that a first-year (or going-in) cap rate of 12% is reasonable for valuation purposes. A lender requires a minimum DSCR of 1.25x and will loan up to 75% of appraised value on a first mortgage. Say the mortgage interest rate is 6.75%, payments are monthly, and the amortization period is 20 years. (10 points) Hint: solve for the debt service.
a)
What is the implied loan size using the DSCR criteria? | |
What is the implied loan size using the LTV criteria? |
b) Based on your response to the previous question(s): What is the maximum-sized loan a risk-adverse lender will advance? (5 points)
c) Suppose 10-year Treasury bond yields in the bond market are 7.5% Bond Equivalent Yield (BEY), and the mortgage market requires a contract yield risk premium of 225 basis points above the BEY. If a property has an annual net operating income (NOI) of $400,000, and the underwriting criteria require a debt service coverage ratio (DSCR) of at least 1.25x, then what is the maximum loan that can be offered assuming a 30-year amortization rate and monthly payments on the mortgages? (10 points) Hint: first find the mortgage equivalent yield, and then solve for the debt service.
MEY (%): | |
Annual Debt Service: | |
Monthly Debt Service: | |
Loan Amount: |
Part (a):
Given, First year NOI= $1 Million, Minimum DSCR=1.25x Therefore, maximum monthly loan payment = ($1Million/12)/1.25 = $ 66,666.67 Loan amount corresponding to the above monthly payments (Implied loan size using DSCR criteria)= $8,767,730.43 as follows: Also given, Cap rate= 12% and LTV=75% Property value= NOI/Cap rate= $1,000,000/0.12 = $ 8,333,333.33 Implied loan size using LTV criteria= $ 8,333,333.33 *75% = $6,250,000 Part (b): A risk averse lender will advance the loan amount based on LTV criteria, ie., $6,250,000 being the lower of the two. Part (c): Given, Bond equivalent yield (BEY)= 7.5% and risk premium= 225 bps. Mortgage equivalent yield (MEY)= BEY+Risk premium= 7.5% + 2.25% = 9.75% Also given, initial NOI= $400,000 and Minimum DSCR=1.25x Therefore, annual Debt service= $400,000/1.25= $320,000 Monthly debt service= $320,000/12 = $ 26,666.67 Loan amount corresponding to the monthly debt service= $3,103,827.01 as follows: |