Equity, Gearing and Leverage Flashcards
An investor group recently purchased an industrial property for $8,500,000. The purchase reflected a net return of 10% (ungeared).
They used interest only mortgage finance at 7.25% to secure the property at a loan to value ratio of 65%.
Calculate the initial return on equity achieved by the investors.
NOTE: Round your answer to 2 decimal places.
Between 15.09 and 15.11
ANSWER
Owners Equity - 2,975,000 (8,500,000 X 0.35)
Loan Amount - 5,525,000 (8,500,000 x 0.65)
Interest Payment - 400,562.50 (5,525,000 x 0.0725)
Net Income - 850,000
Net Income after Interest - 449,437.50 (850,000 - 400,562.50)
Initial Return on Equity
449,437.5 / 2,975,000 = 15.10%
An investor is considering the purchase of an investment property having a gross income of $86,000 per annum and with outgoings of $9,000 paid by the owner. The asking price is $965,000. Fixed interest only finance is available at 6.5%. The investor has a deposit of $300,000.
On the basis that the investor purchases the property at the asking price, what percentage return on equity will the investor achieve?
NOTE: Round your answer to 2 decimal places
Between 11.25 and 11.27
WORKED ANSWER - Net Rent is 77,000. Interest payable is 665,000 x 0.065 = 43,225. Net Income after interest is $ 33,775.
RETURN ON EQUITY IS (33,775 / 300,000) x 100 = 11.26%
An investor is about to purchase a commercial office building for $3,300,000 and which has a net rental of $231,000.
Interest only finance is available at 6.5% per annum up to a maximum LVR of 65%.
Calculate the LVR that would show the greatest return on equity for the investor.
Between 65 and 65
Yield is 7% and interest only finance is 6.5%.
Therefore the more you borrow the greater the return on equity.
Max LVR is 65%, so answer is 65
A property investor is considering the purchase of a block of flats for $5,500,000.
If the maximum LVR is 70%, how much equity will the investor need to have to be able to go ahead with the purchase?
(LVR means Loan to Value Ratio).
Between 1,650,000 and 1,650,000
WORKED ANSWER - $5,500,000 x 0.3 = $ 1,650,000
3 years ago an investment group purchased a property showing a 10% net return at a purchase price of $6,250,000.
In purchasing the property, the investors utilised a 60% LVR to obtain a 5 year interest only mortgage at 7.25% p.a.
Since the purchase, capitalisation rates have hardened / compressed by 2% and the net rental has increased by 15%.
What is the current return on equity being achieved by the investor group?
NOTE: Round your answer to 2 decimal places.
TIP: Current Equity incorporates any capital gain or loss that has occurred.
Between 8.52 and 8.54
WORKED ANSWER
Original Purchase Price $ 6,250,000
Original Net Rental $ 625,000 (6,250,000 x 10%)
Original Equity $2,500,000 (6,250,000 x 40%)
Original Loan Amount $3,750,000 (6,250,000 x 60%)
Interest Payment $ 271,875 (3,750,000 x 0.0725)
Current Net Rental $ 718,750 (625,000 x 1.15)
Current Net (after interest) Income $ 446,875 (718,750 - 271,875)
Current Market Value $ 8,984,375 (718,750 / 8 x 100)
Current Investor Equity $ 5,234,375 (8,984,375 - 3,750,000)
Current Return on Equity 8.54% (446,875 / 5,234,375 x 100)
An investor has agreed to purchase a retail shop which has a net income of $75,000 per annum. The agreed selling price reflects a net return of 5.5%. The bank has told the investor that they will lend up to a 100% LVR if the investor uses additional properties together with the retail shop as securities for the loan. Interest only finance is available at 6% per annum.
Calculate the LVR that will show the greatest return on equity for the investor.
Between 0 and 0
The interest rate is higher than the yield, so the lower the gearing the greater the return on equity.
So if we used 100% equity to purchase the property, the return on equity will be the same as the capitalisation rate.
You have owned an investment property for 6 years. Over that period the rental has remained stable, however due to a decrease in market capitalisation rates, the value of the property has gone up. This would mean that:
NOTE - Select all correct answers
A. the owners equity has gone up
B. the owners annual return on equity has gone down
C. the owners annual return on equity has gone up
D. the owners equity has gone down
A. the owners equity has gone up
B. the owners annual return on equity has gone down
The owner equity has gone up because the property is now worth more than when they bought it and the loan against it has remained the same.
The owners return on equity has gone down, because the owner now has more equity, but the property income has remained the same.
- An investor is considering the purchase of an industrial property.
- It returns $ 325,000 per annum with outgoings of $47,000 paid by the lessor. The asking price is $2,700,000.
- The investor can get mortgage finance at 7.25% and has a deposit of $ 750,000.
What is the gearing ratio or LVR (Loan to Value Ratio)?
LVR
Amount financed: $2,700,000 - $750,000 = $1,950,000
LVR
= $1,950,000 / $2,700,000 x 100
= 72.22% (implies 27.78% equity)
- An investor is considering the purchase of an industrial property.
- It returns $ 325,000 per annum with outgoings of $47,000 paid by the lessor. The asking price is $2,700,000.
- The investor can get mortgage finance at 7.25% and has a deposit of $ 750,000.
What is the return on equity (RoE)?
Interest Payment: $1,950,000 x 7.25% = $141,375 p.a.
RoE
= ($325,000−$47,000−$141,375) / $750,000 x 100
= 18.22%
Background
* An investor is considering the purchase of an industrial property.
* It returns $ 325,000 per annum with outgoings of $47,000 paid by the lessor. The asking price is $2,700,000.
* The investor can get mortgage finance at 7.25% and has a deposit of $ 750,000.
What is the return on equity (RoE)
Background
* An investor is considering the purchase of an industrial property.
* It returns $ 325,000 per annum with outgoings of $47,000 paid by the lessor. The asking price is $2,700,000.
* The investor can get mortgage finance at 7.25% and has a deposit of $ 750,000.
What is the return on equity (RoE)
18.22%
An investor is offered a return of 18% for his equity in a
new development project. This would mean selling a
property he currently holds.
That property was bought for $12,500,000 six years ago on
a financial gearing ratio of 60:40. At the time the net rental
was $ 1,800,000.
Today the property is worth $ 14,000,000 with a net rental
of $ 1,900,000.
The loan was for an 8 year period at 8.5% fixed.
What is the historical equity?
Based on original value of property
Equity = 40% x $12,500,000
LVR = $5,000,000
An investor is offered a return of 18% for his equity in a new development project. This would mean selling a property he currently holds.
That property was bought for $12,500,000 six years ago on a financial gearing ratio of 60:40. At the time the net rental was $ 1,800,000.
Today the property is worth $ 14,000,000 with a net rental of $1,900,000.
The loan was for an 8 year period at 8.5% fixed.
On the basis of the current return on equity only, would you advise the investor to sell the building and take up the
offer in the new project?
RoE:
Interest Payment: $7,500,000 x 8.50% = $637,500 p.a.
Current Net Return (after interest): $1,900,000-$637,500 = $1,262,500
Current Equity: $5,000,000 + $1,500,000 (capital gain) = $6,500,000
RoE = $1,262,500$6,500,000 x 100 = 19.42%
Conclusion: Keep the property as the return on equity is above 18%
