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15 Cards in this Set
- Front
- Back
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A reason to borrow money is to take advantage of
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tax deductibility of mortgage interest and financial leverage
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interest lower than the expected rate of return on total funds invested in a property
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financial leverage
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if the return on the total investment invested in a property is greater than the rate of interest on the debt, the return on equity is
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magnified
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Why does BTIRR increase when debt is used
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Because unleveraged BTIRR is greater than the interest paid on the debt.
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What are the limits for the amount of debt that may be used?
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first, various amounts of debt may exceed lenders debt coverage ratio limit. second, higher ltv ratios and declining debt coverage ratios increase risk to the lender. third, additional borrowing has additional risks for the equity investor.
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uses of more debt will maginify losses on equity invested in property.
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negative (unfavorable) financial leverage.
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ATIRRd > BTIRRp
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negative financial leverage
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BTIRRp must exceed ----- for the leverage to be facorable
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BTIRRd
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When BTIRRp is less than BTIRRd then BTIRRe is also
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less than BTIRRd
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the maximum interest rate that could be paid on the debt before the leverage becomes unfavorable. represents the interest rate at which the leverage is neutra (neither favorable or unfavorable)
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break even interest
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ATIRRd = ATIRRp
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point of neutral leverage
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ATIRRd can be estimated as follows
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ATIRRd=BTIRRd (1-t)
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Break even equation.
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BTIRRd = ATIRRp/1-t
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at high amounts of debt a higher interest rate may have to be paid to obtain additional financing.
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incremental cost of debt
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the implicit cost associated with the use of financial leverage is
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higher risk
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