James purchased a commercial property at a 7.5% cap rate. The previous owner agreed to finance the deal at 8%. Why may James ele

Question

kumpel [21]

3 years ago

11

James purchased a commercial property at a 7.5% cap rate. The previous owner agreed to finance the deal at 8%. Why may James ele

ct not to go ahead with the financing?

Business

1 answer:

dlinn [17] · Answer 1 · 2022-01-18T21:36:44+03:00

Answer:

James will lose money, since his earnings will be lower than the interest that he must pay.

Explanation:

The capitalization (cap) rate is a ratio calculated by dividing the net operating income over the property asset value.

For example, if James is purchasing the property at $100,000, his net earning will be $7,500 per year (cap rate of 7.5%), but he will have to $8,000 in interests for the property. The interests are higher than the earnings, therefore the leverage is negative.