Underwriting an Income Property

An investor wants to finance a project in Canada with a value of $1.5 million with a 70 percent, 25-year loan* at a nominal (face) rate of 8 percent. The project's NOI is expected to be $120,000 during year 1 and the NOI, as well as its value, is expected to increase at an annual rate of 3 percent thereafter. The lender will require an initial debt coverage ratio of at least 1.20. Assume the outgoing cap rate is equal to the ingoing cap rate and the sale in Year 4 is based on Year 5 NOI.

*Dont forget that Canadian Mortgages compound semi-annually.

If you are not familiar with amortizing mortgages, you can use the Financial Functions in Excel. The function requires that you work with five (5) variables: Pmt, Nper (in months), Pv, Fv and Rate. Also you need to decide if the payments are at the beginning or the end of the period (they are at the end that is you get the loan and make the first payment at the end of the first month).

a. What would be the investor's after debt yield on equity (AD IRR)? b. Based on the projection in (a), what would be the maximum loan amount that the lender would make if the debt coverage ratio was 1.15 for year 1? c. What would be the loan-to-value ratio? d. What would be the leveraged IRR with the new loan?