| The cost of capital for a property is called the Loan | | | | Constant = .07916 x 100 = 7.916% (rounded) |
| Constant (Constant) or Mortgage Constant. All loans | | | | Since the borrower knows the Debt Service |
| have a certain interest rate and, unless there is an | | | | Coverage Ratio must be 125% more than annual debt |
| interest-only portion to the loan, all loans will require a | | | | payments he can calculate the annual payments as |
| principal and interest payment. The principal is | | | | the following: |
| calculated based upon the amortization of the loan. | | | | $560,000 = $448,000 |
| Thus, if the loan has a 30-year amortization, which is | | | | 1.25 |
| equal to 360 months, the principal must be paid in 360 | | | | With $448,000 of the property's net operating income |
| installments so the loan is paid in full on the last loan | | | | available to service the debt payments, his maximum |
| payment. | | | | possible mortgage based on debt service would be: |
| The quoted interest rate of a loan is strictly the | | | | $448,000 = $5,659,424 |
| amount of interest that loan accrues. The loan | | | | .07916 |
| constant, on the other hand, is expressed as an | | | | As illustrated, the loan constant is a tool that can help a |
| interest rate that incorporates both the interest and | | | | borrower easily understand the potential debt service |
| principal repayment of a loan. The formula is: | | | | associated with a property based upon a certain net |
| Loan Constant = [Interest Rate / 12] / (1 - (1 / (1 + | | | | operating income. Any borrower should make sure |
| [interest rate / 12]) ^ n))n = the number of months in | | | | they check the loan constant with their lender to |
| the loan term | | | | ensure that it matches his assumptions. For example, |
| Example 1: Suppose an investor received a loan for | | | | FHA multifamily mortgages have a mortgage |
| $4,000,000 at a 5.50% interest rate with a 30-year | | | | insurance premium that is also factored into the loan |
| amortization. We can calculate the required annual loan | | | | constant which raises a property's cost of capital. A |
| payments once the loan constant is known. | | | | few other items to remember are: |
| Constant = [.055 / 12] / (1 - (1 / (1 + (.055 / 12]) ^ 360)) | | | | Shortcoming #1: The constant only works for fixed |
| Constant = .06813 x 100 = 6.813% (rounded) | | | | rate loans. For adjustable rate mortgages that have |
| Annual payments = $4,000,000 * .06813 = $272,520 | | | | changing monthly interest rates lenders will typically |
| While the property has an interest rate of 5.50% the | | | | underwrite the maximum possible interest rate for that |
| investor's actual cost of capital for the loan is 6.813% | | | | loan. Find out from your lender what is appropriate |
| once the principal payment has been factored. If the | | | | when modeling debt assumptions. |
| above loan scenario has a 1.25x debt service | | | | Shortcoming #2: The constant changes based upon |
| coverage ratio (DSCR) requirement then an investor | | | | the amortization of the mortgage. While not |
| knows that the property must have at least the | | | | necessarily a shortcoming, it is important to understand |
| following NOI to support the loan: | | | | the terms of any loan quote you receive from a lender |
| $272,520 x 1.25 = $340,650 | | | | or if your loan assumptions are accurate for a |
| Consider that the reverse also holds true. A borrower | | | | particular property or market. The shorter the |
| can factor his potential debt service loan with the loan | | | | amortization period of a loan, the higher the property's |
| constant as long as he knows the NOI. | | | | cost of capital. |
| Example 2: A borrower wants to refinance his loan. | | | | Shortcoming #3: The constant does not factor |
| His NOI is $560,000 and he has heard that his local | | | | interest-only periods. In the current lending |
| bank will give him an interest rate of 6.25% for 25 | | | | environments, most lenders use an amortizing constant. |
| years with a minimum DSCR of 1.25. What is the | | | | When modeling cash flow it is important to note an |
| maximum loan he can borrower subject to an | | | | interest only periods but although it will increase the |
| appraisal? | | | | cash-on-cash returns, it will not change the loan |
| Constant = [.0625 / 12] / (1 - (1 / (1 + (.0625 / 12]) ^ | | | | amount. |
| 300)) | | | | |