Consider a suburban mall that generates total lease income of $40m per year. Operating expenses of running the mall are $7m per year. The mall is financed by an interest-only commercial mortgage with an interest rate of 4% per annum.

a. How would you go about assessing what an appropriate cap rate would be for valuing this property?

b. Assume that an appropriate market cap rate for this type of property is 5%. What is your valuation of this property?

c. Assume the mortgage has an LTV of 80% (use your answer from part 1 as the valuation). What is the DSCR on the mortgage?

d. Would the DSCR be higher or lower if this was an amortizing mortgage instead of an interest only mortgage? Why?

e. The DSCR is commonly used as an underwriting criteria for commercial real estate lending. Briefly explain how it is used, and why it is a useful statistic for assessing credit risk for commercial mortgages. Also give an example of a situation in which it might give a misleading picture of the credit risk embedded in the commercial mortgage.