Consider a commercial property that costs $1 million (90% building, 10% land)
Subject: Business / Finance
1. Consider a commercial property that costs $1 million (90% building, 10% land) with the CAP rate of 10%. Assume that the operating cash flow and value of the property both grow at a rate of 5% per year. Suppose 80% of the property value is financed with a constant payment mortgage of 30 year amortization and 10% interest rate with monthly payments. Assume 31.5 years of straight line depreciation, Income tax rate of 40%, 20% capital gain tax rate and 20% depreciation recapture. Holding period 5 years. (a) What is the equity before-tax IRR? (a) What is the equity after-tax IRR?
2. Bob is considering acquiring a commercial property for $100,000 (90% building +10% land). He expects the property will generate NOIs of $10,000 in year 1, $11,000 in year 2, $12,000 in year 3 and $12,500 in year 4. He wants you to do a three-year cash flow simulation. He expects the cap rate on the property in three years to be the same as the one at purchase. He is offered an $80,000 interest only 3-year participating mortgage with annual payments of 7% interest plus 50% kickers on any annual cash flow above $11,000 and property value at maturity above $100,000. Assume 39 years straight-line depreciation, income tax rate 30%, 15% capital gain tax, and 20% depreciation recapture tax rate. (a) What is the before tax property expected return? (b) What is the yield to maturity (YTM) on the loan assuming Bob will not default on the loan?
(c) What is the before-tax and after-tax returns on Bob’s equity assuming he takes the loan? (d) The lender may be interested in offering a convertible mortgage with 7% interest payments rather than the participating mortgage. At the end of year three, the lender can choose to convert the mortgage into 70% of the property value, what is the before-tax and after tax IRR of Bob’s equity? What is the YTM of the convertible mortgage?