Question

A proposed acquisition of a multifamily ‘value add’ project has a capitalization rate of 7%, and...

A proposed acquisition of a multifamily ‘value add’ project has a capitalization rate of 7%, and project Un-levered IRRs of 10% over five years. However, you are told that the acquisition could be done with the following capital structure: 60% 1st mortgage debt at an 8% rate, 10% mezzanine debt at an 11% rate, and 30% equity. With the new capitalization, the levered returns are projected to be 15% over five years. Given that the first mortgage debt and mezzanine debt rates are higher than the capitalization rate, why is the levered IRR (15%) higher than the unlevered IRR (10%)? A. Amortization B. Flipping the property in a quick sale C. Growth D. Insufficient information.

A. Amortization

B. Flipping the property in a quick sale

C. Growth

D. Insufficient information

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Answer #1
The weighted average cost of debt in Percentage
60% mortgage debt at 8% X 60% /70% 6.8571428571428600
10% mezzanine debt at 11% X 10%/70% 1.4285714285714300
Weighted Average 8.285714285714290%
Unlevered IRR 10%
Difference is savings in interst 1.7142857142857100%
interest is apportioned between 30% equity 5.714285714285700%

So total 10%+5.714285714285700%,

So Answer is option A. Amortisation

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