Question

You are investing in a shopping center at a price of $7,500,000. a 60% loan is available at 7% interest over 17 years, with a 7 year call. Origination fees will be 3% and will be paid upfront. lender keeps half the fees.

what is the APR (cost of debt)?

what is the lenders expected yield?

Answer 1

Let us take a look at the key assumptions in the question (please refer the excel snapshot below):

Amount of loan available = 60% of US$7.5 Million = US$4.5 Million

Origination fees amount (paid upfront) = 3% of US$4.5 Million = US$135,000 - of this the lender shall keep 50% and the remaining shall go into the processing of the loan

So, the lender keeps US$ 67,500 from the origination fee, which is paid to him upfront

Now, consider the 7 year call - this means that even though the tenor (or period in which the full repayment can be made) is 17 years, lender shall review your loan every 7 years and might demand full payment of the loan at such review. However, the lender shall not be able to demand payment in between the review terms - meaning that you might need to release full payment at the end of Year 7 or Year 14 or can carry on your payout as usual till the end of Year 17.

Now to solve the question:

a) APR - Annual Percentage Rate is the actual cost of the debt taking into account other expenses, which in our case is the origination fee

So, first we shall need to calculate the actual interest that we shall be paying over the course of the loan (here we shall consider loan tenor to be 17 years).

We can use the IPMT (to calculate interest payment every year) and PPMT formula (to calculate principal payment every year) in excel to set up a loan amortisation schedule as shown below:

So, the total interest paid in 17 years = US$3,335,527 (adding up the "interest pay" column) in above excel snapshot

So, effective annual interest paid = US$ 196,207 (dividing above total interest by 17 years). We need to add to this the fees paid upfront, i.e. US$135,000

So the total effective cost of the debt = US$ 331,207. Upon dividing this by the loan amount of US$4.5 Million, we obtain the APR = 7.36%

b) Lender's Expected Yield

Now, there can be 3 scenarios - call of the debt after 7 years, call of the debt after 14 years and full payout of the debt in 17 years. We shall need to assume that each of these scenarios is equally likely and therefore shall have a 33.3% chance of occuring.

We need to find the lender's yield in each of these scenarios and then add them up to obtain the Expected Yield

Lender's Yield is nothing but the IRR of the cash outflows and inflows for the lender during each scenario (each case shall also consider US$67,500 origination fee received by the lender upfront and the US$4.5 Million loan disbursal by the lender upfront)

Hence expected Lender yield = 6.97%