Question

Ann purchased a property for $1,000,000. She bought the property at a 7.00% cap rate. She finances the purchase with an Interest Only senior loan at 60% LTV at an interest rate of 4.00%. She also decides to get subordinate / mezzanine financing for 20% of the capital stack (from 60%-80% LTV) at 8.00% interest only. What is Ann’s return on equity (ROE) in year 1?

Answer 1

Solution:-

Given Data:-

Property Value = $ 1,000,000,

Senior Loan:

Loan to Value = 600,000 (60%)

Interest Rate = 4%

Subordinate Loan:

Loan to Value = 400,000 (60% to 80%)

Interest Rate = 8%

Equity = 200,000.

Calculation of Ann’s return on equity (ROE) in year 1:-

Property Value = $ 1,000,000

Cap Rate 7 % = ($ 1,000,000 * 7%) = $70,000 (a)

Interest Cost

Senior Loan = $ 24,000

Subordinate Loan = $ 16,000

Total Interest Cost = $ 24,000 + $ 16,000 = $ 40,000 (b)

Net Return (a-b) = $ 70,000 - $ 40,000

= $ 30,000.

Equity = 2,00,000

So, Return on Equity = 15.00 %

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