PLEASE SHOW WORK An investment property has a quoted overall capitalization rate
ID: 2781824 • Letter: P
Question
PLEASE SHOW WORK
An investment property has a quoted overall capitalization rate of 8%. You can obtain a 25-year, fully amortizing loan at a stated interest rate of 4.5% to purchase this property, and the maximum loan-to-value that the lender will allow is 80% (and you will want to use as much debt as possible to buy this property). The property’s asking price is $5,000,000 and you deem this a reasonable price to pay. There are many ways to answer these next two questions, and all give you the same answers.
What is the loan constant (the lender’s rate of return)? PLEASE SHOW WORK
What is the equity dividend rate (your investment rate of return, or dividend yield)?PLEASE SHOW WORK
Explanation / Answer
The cost of capital for a property is called the loan constant or mortgage constant. All loans have a certain interest rate and unless there is interest only portion to the loan , all the loans will require a principal and interest payment. the principal is calculated based upon the amortization of the loan. Thus if a loan has a 30 yera amortization which is equal to 360months the principal must be paid in 360 installment so the loan is paid in the full on the last loan payment.
The quoted interest rate of a loan is strictly the amount of the interest that loan accrues. The loan constant on the other hand is expressed as an interest rate that incorporates both the interest and principal repayment of a loan. The formula is
Loan constant =[Interest rate/12](1-[1[1+[interest rate ])*n))
n= number of months in the loan term
The equity dividend rate (also called the equity capitalisation rate and cash on cash return ) is the ratio of a single year's before tax cash flow and the equity investment in the property .
formula equity dividen d rate=equity investment efore tax cash flow
The euity dividend rate shows the return on the money actually invested.
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