Calculate the rate of return to a real estate investor who uses 70% financing at a cost of 6% for the purchase of investment property at a price of $3,000,000. The investment loan is an interest only loan paid quarterly for five years with a balloon payment due at the end of the fifth year. The investment plans to sell the property at the end of the 5th year of ownership. When the property is sold, the expected selling expenses are 10% of the selling price.
The cash flow projections indicate that the rate of return on the total $3,000,000 purchase price are expected to generate a return on the total asset value of 9% per year.
a) What is the rate of return on the equity investment for a buyer who pays cash to purchase this investment property?
b) What is the rate of return on the equity for each year of ownership, if the buyer uses the 70% loan to value ratio at a cost of 6% interest per year?
c) What happens if because of unexpected vacancy and repairs, the return on total asset value drops to 5% per year instead of the expected 9%?
d) What are the two possible rates of return to the investor on this property when using the financing and selling the property after 5 years? (9% return on asset value vs 5% return on asset value
e) What is the return to the investor when paying in cash and selling after 5 years?
Should the investor pay cash or use the available financing to purchase the property?