Question

You are considering purchasing an office building for $2,500,000. You expect the potential gross income (PGI) in the first year to be $450,000; vacancy and collection losses to be 9 percent of PGI; and operating expenses and capital expenditures to be 42 percent of effective gross income (EGI). You will finance the acquisition with 25 percent equity and 75 percent debt. The annual interest rate on the debt financing will be 5.5 percent. Payment will be made monthly based on a 25-year amortization schedule.

What is the debt yield ratio?

Answer 1

Potential Gross Income(PGI) = $450000

Now vacancy and collection losses are 9% of PGI,

therefore, vacancy and collection losses = 9%(450000) = $40500

Then, Effective Gross Income(EGI) = 450000-40500 = $409500

Operating expenses and capital expenditures = 42%(409500) = $171990

Net Operating Income = EGI-Operating expenses = 409500-171990 = $237510

In order to calculate the Debt yield ratio, we need the debt amount and NOI

so we have NOI = $237510

and Debt/Loan amount = 75%(2500000) = $1875000

Debt Yield ratio = NOI/Loan amount

= 237510/1875000 = 0.126672

= 12.67%