FRM Part II · FRM Exam Part II · Private Markets Investing
A real estate investor buys a property for USD 50 million with USD 30 million of debt at 5% interest-only. Year-1 net operating income (NOI) is USD 3.0 million. What is the going-in cap rate and the year-1 levered cash-on-cash return on equity (before taxes, ignoring fees and principal)?
The going-in cap rate is 6.0% (NOI of 3.0 million divided by price of 50 million). Interest is 1.5 million, leaving 1.5 million of cash flow on 20 million of equity, giving a levered cash-on-cash return of 7.5%.
- ACap rate 6.0%; cash-on-cash 7.5%Correct
- BCap rate 6.0%; cash-on-cash 4.5%
- CCap rate 10.0%; cash-on-cash 7.5%
- DCap rate 6.0%; cash-on-cash 15.0%
Explanation
Cap rate = 3.0/50 = 6.0%. Interest = 30 x 5% = 1.5 million. Cash flow to equity = 3.0 - 1.5 = 1.5 million on equity of 20 million = 7.5%. Option with 4.5% divides 0.9 by 20 (wrong), 15% ignores interest.
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