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24 September, 22:19

James purchased a commercial property at a 7.5% cap rate. The previous owner agreed to finance the deal at 8%. Why may James elect not to go ahead with the financing?

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  1. 24 September, 23:00
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    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.
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