A property with a trailing cap rate of 5.7% was purchased for $28,480,000. The purchase was financed using an interest-only debt of 70% at an interest rate of 5.85% per annum. Capital improvements are $238,000 and structural reserves are $115,000 in Year 1. The income return on equity (ROE) for this property at the end of Year 1 is:
Question
A property with a trailing cap rate of 5.7% was purchased for 238,000 and structural reserves are $115,000 in Year 1. The income return on equity (ROE) for this property at the end of Year 1 is:
Solution
First, let's calculate the Net Operating Income (NOI) using the cap rate formula:
NOI = Purchase Price * Cap Rate NOI = 1,623,360
Next, let's calculate the loan amount:
Loan Amount = Purchase Price * Loan-to-Value Ratio Loan Amount = 19,936,000
Then, we calculate the annual interest payment:
Interest Payment = Loan Amount * Interest Rate Interest Payment = 1,165,656
Now, let's calculate the Cash Flow from Operations (CFO) by subtracting the capital improvements and structural reserves from the NOI:
CFO = NOI - Capital Improvements - Structural Reserves CFO = 238,000 - 1,270,360
The Cash Flow After Financing (CFAF) is calculated by subtracting the interest payment from the CFO:
CFAF = CFO - Interest Payment CFAF = 1,165,656 CFAF = $104,704
Finally, we calculate the Return on Equity (ROE) by dividing the CFAF by the equity. The equity is the purchase price minus the loan amount:
Equity = Purchase Price - Loan Amount Equity = 19,936,000 Equity = $8,544,000
ROE = CFAF / Equity ROE = 8,544,000 ROE = 0.0123 or 1.23%
Therefore, the income return on equity (ROE) for this property at the end of Year 1 is 1.23%.
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