Question

You are considering the purchase of a 50,000 square -office building with an asking price of $10,000,000. Rent per square foot is $40, vacancy is 15% and operating expense/ capital expenditures is 52% of effective gross income. You are considering injecting equity to the tune of 20% of the purchase price and borrowing the balance.

Typical financing is 7% per year for 10 years, amortized over 25 years. The lender requires a Debt Coverage Ratio (DCR) of 1.35.

i) Would you qualify for the loan amount you are seeking under the lender's DCR constraint? Show your computations clearly

ii) If not, how much more equity will you need to inject under the maximum loan possible?

Answer 1

Income per Year Possible with 15% Vacancy, 50,000 sqft and rent of $40 per Sqft. = $1,700,000

Operating Expenses = 52% of Income ==> 48% is Net Operating Income

Net Operating Income = $816,000

If You require Debt Coverage Ratio of 1.35

==> 1.35 * Debt Service = Net Operating Income

==> Debt service = Net Operating Income / 1.35 = $816,000/1.35 = $604,444

So Equated Annual Installment of $604,444 for 25 years at 7%

==> Present Value of $604,444 annual with 7% rate and 25 years is $7,043,938.43

That means that only 7.044 Million USD can be borrowed.

OR,

for 8 Million USD, The debt service each year is

EAI for 25 years, present value of $8 Million and 7% is $686,484

That gives a Debt Coverage Ratio of 1.1887 which would not qualify for the loan.

i.) No

ii.) Additionally, 0.56 Million USD of Equity needs to be brought in.