Question

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You are considering the purchase of a quadruplex apartment building. Effective gross income during the first year of operations is expected to be $33,600 ($700 per month per unit). First-year operating expenses are expected to be $13,440 (at 40 percent of EGI). Ignore capital expenditures. The purchase price of the quadruplex is $200,000. The acquisition will be financed with $60,000 in equity and a $140,000 standard fixed-rate mortgage. The interest rate on the debt financing is 8 percent and the loan term is 30 years. Assume, for simplicity, that payments will be made annually and that there are no up-front financing costs.

a. What is the overall capitalization rate?

b. What is the effective gross income multiplier?

c. What is the equity dividend rate (the before-tax return on equity)?

d. What is the debt coverage ratio?

e. Assume the lender requires a minimum debt coverage ratio of 1.2. What is the largest loan that you could obtain if you decide that you want to borrow more than $140,000?

Answer 1

As per rules I will answer the first 4 sub parts of this question

a.NOI = EGI – operating expenses

=33,600 – 13,440

= $20,160

Capitalization rate = NOI / Market price

= 20,160 / 200,000

= 10.08%

b: Gross Income Multiplier = Market price / Effective gross income

= $200,000 / $33,600 = 5.95

c: Debt Service= 12436

(In financial calulator, find pmt when N=30,I/YR=8,PV=140000)

Before-tax cash flow = NOI - Debt service

= 20,160 - 12,436

=7,724

Hence the Equity dividend rate = Before-tax cash flow / equity

=7,724 / 60,000 = 12.87

d:

DCR= NOI / debt service

=20160/12436 = 1.62