Question

5. Which of the following is NOT true obtaining bank financing for a property?

(A) The interest expense is a tax shield and will lower the taxable income

(B) A higher LTV loan has greater risk and return potential and therefore will have a greater impact on IRR, Equity Multiple and ROE (return on equity) than a lower LTV loan

(C) When underwiring a loan banks, prefer higher, rather than lower, debt service coverage ratios and debt yield ratios

(D) Banks prefer to lend to construction projects (properties under development) since the property is better collateral and less risky than an older (stabilized) property

(E) All of the above is true

Answer 1

Answer:

Correct answer is:

(D) Banks prefer to lend to construction projects (properties under development) since the property is better collateral and less risky than an older (stabilized) propert

Explanation:

Interest expense is tax deductible. Hence interest expense lowers taxable income.

Higher loan to value ratio has greater risk and return potential and higher impact on IRR, Equity Multiple and ROE (return on equity) as compared to lower LTV loan.

Higher the debt service ratio, better it is. Banks prefer higher, rather than lower, debt service coverage ratios and debt yield ratios.

As such statements A, B and C are true.

But statement D is not true. Stabilized properties are less risky as compared to construction projects (properties under development). Banks may prefer a mortgage loan rather than construction loan. It is easier to get a standard mortgage loan rather than a construction loan.