Question

A property has just come to the market for 3 million. You plan on acquiring the property, hold for one year, and then sell it. You have the option to finance the project with an interest-only loan with a maximum LTV of .60 with a 5% interest rate and your annual income places you in the 25% marginal tax bracket. The NOI in the first year of ownership will be $255,000 and is expected to increase by 2% each year for the foreseeable future.

A)What is the initial cap rate associated with this investment? IF the terminal cap rate equals the initial cap rate, what is you estimate of value when the property is sold at the end of the first year?

B)If you purchase the property without the use of debt, what is your after-tax return on your equity

C)If you purchase the property using the mortgage described in the problem statement and assume that you will take the largest loan amount allowed, what is your after-tax return on equity.

Answer 1

Solution:- Given Data:-

LTV=0.6

Current Market Price of the asset, CMP=3 million

In case of loan, interest rate, ROI=5%=0.05

Net operating Income in First year, NOI=255000

and is expected to grow by 2% each year to forseeable future

(A)Capitalization Rate or Cap Rate is given by,

Initially,

If Initial Cap Rate= Terminal Cap rate after 1year, then

OR

(B)If purchase of the property is done without the use of debt, then Return On Equity (ROE) will be

As the company is unlevered i.e. purchase is done without use of debt.

To calculate after-Tax ROE,

   OR 6.37%.

(C) If the purchase of property is done using the mortgage, then

Maximum Loan amount that can be availed is to be calculated,

OR

To calculate After-tax ROE,

OR 17.2%