A lender requires a 1.25 debt coverage ratio on a loan with a 7.5% mortgage constant covering 70% of value. The implied cap rate by the DCR technique is:
Correct Answer
B) 6.6% before the equity share
Why this is correct: The governing concept is the Debt Coverage Ratio (DCR) technique to estimate a capitalization rate: Cap Rate = DCR × Mortgage Constant × Loan-to-Value Ratio. Here, DCR = 1.25, Mortgage Constant = 0.075, LTV = 0.70. Calculation: 1.25 × 0.075 × 0.70 = 0.065625, or 6.6% rounded. This reflects the minimum cap rate needed to satisfy the lender's requirements. Why the other choices are wrong: "7.1% from the lender's side" is incorrect because it does not match the calculation. "8.2% after rounding up" is incorrect as it's not the result of the formula. "9.4% including the equity residual" is incorrect because the DCR technique yields the overall cap rate before considering equity yield. Exam tip: The DCR-derived cap rate is a useful benchmark when sales data is scarce, reflecting lender underwriting standards.
Why This Is the Correct Answer
Why this is correct: The governing concept is the Debt Coverage Ratio (DCR) technique to estimate a capitalization rate: Cap Rate = DCR × Mortgage Constant × Loan-to-Value Ratio. Here, DCR = 1.25, Mortgage Constant = 0.075, LTV = 0.70. Calculation: 1.25 × 0.075 × 0.70 = 0.065625, or 6.6% rounded. This reflects the minimum cap rate needed to satisfy the lender's requirements. Why the other choices are wrong: "7.1% from the lender's side" is incorrect because it does not match the calculation. "8.2% after rounding up" is incorrect as it's not the result of the formula. "9.4% including the equity residual" is incorrect because the DCR technique yields the overall cap rate before considering equity yield. Exam tip: The DCR-derived cap rate is a useful benchmark when sales data is scarce, reflecting lender underwriting standards.
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