A client is considering the purchase of a fourplex for $600,000, with $150,000 in cash and a $450,000 loan with annual debt service of $30,000. The client requires a 9% first-year cash-on-cash return. What minimum annual NOI must the fourplex produce to meet this requirement?
Correct Answer
B) $43,500
The required cash flow is 9% of the $150,000 equity, or $13,500, and NOI must also cover the debt service: $13,500 + $30,000 = $43,500. Applying 9% to the loan gives $40,500, and applying it to the full price gives $54,000, but the return is measured on cash equity. Applying 9% to the loan and then adding debt service gives $70,500.
Why This Is the Correct Answer
Option B is correct because a 9% return on $150,000 of equity requires $13,500 of cash flow. NOI must cover that plus $30,000 of debt service, so $13,500 + $30,000 = $43,500.
Why the Other Options Are Wrong
Option A: $40,500
Option A, $40,500, applies 9% to the loan: $450,000 × 0.09 = $40,500. The return is measured on the $150,000 of equity, and NOI must equal $13,500 + $30,000 = $43,500.
Option C: $54,000
Option C, $54,000, applies 9% to the price: $600,000 × 0.09 = $54,000. That treats the target as an overall rate; the target applies to equity, giving $13,500 + $30,000 = $43,500.
Option D: $70,500
Option D, $70,500, uses the loan as the base and then adds debt service: $40,500 + $30,000 = $70,500. Adding debt service is right, but the base should be equity, which gives $43,500.
Lender first, equity next
NOI equals debt service plus the cash flow equity must receive. Build it up in that order.
How to use: Use this split when a problem gives a target return on cash and asks for the income required.
Exam Tip
Check that your answer leaves the stated return after debt service: $43,500 − $30,000 = $13,500, and $13,500 ÷ $150,000 = 9%.
Common Mistakes to Avoid
- -Applying the equity return to the total price
- -Stopping at the required cash flow without adding debt service
- -Using the loan amount as the equity base
Concept Deep Dive
Analysis
Here the return is given and the income is missing. Find the cash the equity must earn, then add back debt service, because NOI pays the lender before the equity receives anything. The base for the return is the cash equity, not the price or the loan.
Background Knowledge
NOI is split between the lender and the equity holder. Debt service is paid first, and what remains is the cash flow on which the equity dividend rate is measured.
Real-World Application
A buyer asks what income a fourplex needs before an offer makes sense at the buyer's target return. The appraiser explains how much NOI the loan payment and the cash return together require, without treating that figure as market value evidence.
More Income Approach Questions
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Previous Question
Market data show that operating expenses, excluding debt service, run 38% of EGI for properties similar to the subject. The subject's annual EGI is $420,000. What is the projected annual NOI?
Next Question
The subject property is a 20-unit apartment building with stabilized annual NOI of $172,800. The most similar comparable sold 18 months ago at an overall rate of 8.50%. Resales of similar buildings show that overall rates for this property type have declined 50 basis points since that sale. What is the indicated value by direct capitalization?