Real estate leverage

CFA Level II Alternative Investments
#1

Just wanted to clarify Two things:

1.how cost of debt impacts real estate value?if interest rates rise it becomes expensive to take loan beacuse of which demand decreases and prices of real estate falls?

2.the amount of leverage.if i either take 10%loan or 80% of the appraised value it would not impact my real estate value?

#2

_ 1.how cost of debt impacts real estate value?if interest rates rise it becomes expensive to take loan beacuse of which demand decreases and prices of real estate falls? _ That’s one reason. Also as rates rise so will cap rates (ie discount rates). Therefore the PV of CF’s will be lower.

_ 2.the amount of leverage.if i either take 10%loan or 80% of the appraised value it would not impact my real estate value? _ It doesn’t affect the VALUE of the property per say because the value (in theory) is just NOI/Cap Rate. NOI is before any debt service - therefore it doesnt matter if you take out debt or not. It will however effect your returns in the same way that leverage effects all investment returns.

#3

Great!! one more thing terminal cap rates are usually higher becuase of the more risk involved with the property(propert is old,if it can sustain the same noi or not) as compared to the going in cap rate?

Thanks for your help.

#4

Yea I think I would add terminal cap rates are higher just due to forecasting error as well.

#5

Thanks a Ton.

#6

Higher terminal cap rate due to higher discount rate

  • discount rate higher because of the higher risk free rate

  • uncertain of amount of physical depreciation of property (uncertain future final cashflow)