Question

Scenario 1: A developer is considering developing a Class A office building. The developers preliminary estimate of value is $2-million. Initial discussions with lenders indicate that loans are available for this type of property at 9 percent interest and 30-year amortization periods, with monthly payments. Lenders have further indicated they are using a 1.2 debt coverage ratio or a 75 percent loan to value for Class A office buildings, whichever equals the lower loan amount. Recent sales for Class A office buildings have indicated that cap rates are in the 9.5 percent range. The developer's forecast of a stabilized NOI is $190,000, which reflects a 4 percent vacancy and $102,800 in operating expenses. 1. Using the owner's preliminary forecast, and the lender's underwriting criteria, what is the maximum loan amount that the developer can expect? maximum loan amount = $ Scenario 2: One of the lenders who is receiving the preliminary application package expressed an interest in the project but explained that their underwriting guidelines require a minimum 7 percent vacancy allowance. The lender asks the developer if this would be a dealbreaker. 2. After adjusting the NOI to reflect the increased vacancy, what is the maximum loan which the developer can now expect? (assume the increase in vacancy will not change or impact the operating expenses) maximum loan amount = $ 3. What information would you need about the borrower to determine if this loan would be acceptable?

Answer 1

1) We have two criteria for the loan to be accepted.

a) 75% of loan to value = 0.75 * 2,000,000 = 1,500,000

b) 1.2 debt coverage ratio = debt coverage ratio = NOI/Debt service

NOI = 190,000, DCR = 1.2 Debt service = 190,000/1.2

= 158,333

based on the debt service amount we will calculate the loan eligibility for the same. Using the PV formula in excel we get

Particulars	Amount
Interest Rate	9.00%
Coupon Payment	158333
No of installments	30
Future Value/Maturity Value	₹ 0.00
Present Value	₹ -1,626,658.46

so based on the above two calculations the developer is eligible for a loan of 1,500,000

Using cap rate also we get value of the property as 2,000,000 = 190,000/0.095

b) The lender have asked to rework the NOI with 7% vacancy allowance.

first we need to calculate the initial gross income of the property we get

Particulars
Gross Income	304167
Vacancy Allowance @ 4%	12167
operating expenses	102000
NOI	190000

The above is a simple mathematical calculation where NOI + Operating expenses = 96% of the gross income so calculate the 100%. by cross multiply we get 304167. Now we will apply the 7% vacancy allowance for the same.

Using 7% vacancy allowance the NOI is

Particulars
Gross Income	304167
Vacancy Allowance @ 7%	21292
operating expenses	102000
NOI	180875

Using NOI 18085, we need to calculate the DCR = 180875/1.2

= 150,729

Particulars	Amount
Interest Rate	9.00%
Coupon Payment	150729
No of installments	30
Future Value/Maturity Value	₹ 0.00
Present Value	₹ -15,48,537.600

Using the 7% vacancy allowance also the maximum loan amount is 1,500,000 because the condition is whichever is lower.

3) we would need the following information about the borrower

a) past financial statements; to study the eligibility criteria and the history of its firm and to also know whether the firm is in debts or has the capacity to pay the debt if project is not progressing smoothly

b) credit history: to understand the way he has paid all his past obligations.

c) past projects: to understand the way the developer has worked, what projects he has completed and how he has delivered the projects.

d) collateral details: collateral details of the project, because if he project fails or the firm is unable to pay up the bank will need collateral to cover the dues.