Question

An income property has 5000 square feet of leasable space, and rents for $8.00 per square foot per year. Vacancy and credit loss are estimated at 4% and operating expenses at 38% of potential gross income. Lenders require a 1.2 Debt Coverage Ratio. Mortgage is available at terms of 25 years, at 15%, payable annually. The investor requires a 14% rate of return on the projects before tax equity cash flow.

What would be your maximum offering price based on this analysis?

a. $152,593        b. $143,442        c. $145,402         d. $144,383

Answer 1

Here the most important part is the debt servicing as the debt coverage ratio should be 1.2. Lets estimate income and expenses:

Potential Income from Lease = $8 * 5000 = $ 40,000

Vacancy and Credi Loss = 4% of 40,000 = - $ 1,600

Net Income from Lease = $ 38,400

Operating expenses = 38% of 40,000 = - $ 15,200

Net Operating Income = $ 23,200

Now we know that Debt Service Coverage Ratio is 1.2 so DSCR = Operating Income / (Principal + Interest )

1.2 = 23200 / Debt Payments

Debt Payments = 23200 /1.2 = $ 19,333.33

Now he can at max pay $ 19,333.33 to maintain the DSCR of 1.2 and now we will check the rate of return on project at 14%

To maintain 14% ROE we need to make sure that the payment done by the investor is such that Net income / Equity is 0.14

Net Income = 23200 - 19333 = 3867

Equity = x

ROE = 0.14

ROE = Net Income / Equity

0.14 = 3867/x

x = 27,621.428

x = 27, 621.43

The price for property should be such that the debt servicing is only $ 19833 for the single time period.

EMI = [P x R x (1+R)^N]/[(1+R)^N -1]

19333 = [ P * 0.15 * (1.15)^25 / (1.15)^25 -1 ]

19333 = P * 4.937842893/31.9189526198

P = 1,24,971.39

The Maximum Amount for the Property would be the addition of Equity to be paid by customer and debt from the bank

Thus 1,24,971.39 +27, 621.43

= 1,52,592.82 = 1,52,593

Thus a is the answer