{"id":19412,"date":"2021-08-11T15:45:59","date_gmt":"2021-08-11T15:45:59","guid":{"rendered":"https:\/\/analystprep.com\/study-notes\/?p=19412"},"modified":"2026-03-02T10:53:11","modified_gmt":"2026-03-02T10:53:11","slug":"financial-ratios-used-to-analyze-real-estate-investments","status":"publish","type":"post","link":"https:\/\/analystprep.com\/study-notes\/cfa-level-2\/financial-ratios-used-to-analyze-real-estate-investments\/","title":{"rendered":"Financial Ratios Used to Analyze Real Estate Investments"},"content":{"rendered":"<script type=\"application\/ld+json\">\r\n{\r\n  \"@context\": \"https:\/\/schema.org\",\r\n  \"@type\": \"QAPage\",\r\n  \"mainEntity\": {\r\n    \"@type\": \"Question\",\r\n    \"name\": \"What is the maximum loan amount given DSCR and LTV constraints?\",\r\n    \"text\": \"A financier will make an 8% interest-only loan on a property provided the debt service coverage ratio (DSCR) is at least 1.6 and the loan-to-value (LTV) ratio does not exceed 60%. The property is appraised at $1,800,000 and has a net operating income (NOI) of $400,000.\\n\\nWhat is the maximum loan amount?\\n\\nA. $250,000\\n\\nB. $1,080,000\\n\\nC. $3,125,000\",\r\n    \"answerCount\": 1,\r\n    \"acceptedAnswer\": {\r\n      \"@type\": \"Answer\",\r\n      \"text\": \"The correct answer is B. First, calculate the maximum loan allowed under the DSCR constraint. Debt service = NOI \/ DSCR = 400,000 \/ 1.6 = 250,000. Since the loan is interest-only at 8%, the maximum loan based on DSCR is 250,000 \/ 0.08 = 3,125,000. Next, apply the LTV constraint: Loan = 60% \u00d7 1,800,000 = 1,080,000. The maximum permissible loan is the lower of the two values, which is $1,080,000.\"\r\n    }\r\n  }\r\n}\r\n<\/script>\r\n<p><iframe loading=\"lazy\" src=\"\/\/www.youtube.com\/embed\/Gl7tl4SCY8k\" width=\"611\" height=\"343\" allowfullscreen=\"allowfullscreen\"><span data-mce-type=\"bookmark\" style=\"display: inline-block; width: 0px; overflow: hidden; line-height: 0;\" class=\"mce_SELRES_start\">\ufeff<\/span><span data-mce-type=\"bookmark\" style=\"display: inline-block; width: 0px; overflow: hidden; line-height: 0;\" class=\"mce_SELRES_start\">\ufeff<\/span><\/iframe><\/p>\r\n<p>Debt financiers often prefer debt service coverage ratio (DSCR) and loan to value (LTV) when arriving at the maximum loan on a definite property. <\/p>\r\n<p>$$ \\text{DSCR} = \\frac {\\text{Year one NOI}}{\\text{Debt service}} $$<\/p>\r\n<p>Where:<\/p>\r\n<p>$$ \\text{Debt service} = (\\text{Interest} + \\text{Principal}) $$<\/p>\r\n<p>Note:<\/p>\r\n<ol type=\"1\">\r\n\t<li>Payment of the principal amount leads to a reduction in the outstanding loan balance.<\/li>\r\n\t<li>An interest-only loan doesn&#8217;t reduce the outstanding loan balance, making the loan balance constant over time.<\/li>\r\n\t<li>Financiers prefer a DSCR of 1.2 or higher to guarantee that the property&#8217;s NOI can cushion the debt service. <\/li>\r\n<\/ol>\r\n<p>The LTV ratio is arrived at as follows:<\/p>\r\n<p>$$ \\text{LTV}= \\frac{\\text{amount of loan}}{\\text{value of appraisal}} $$<\/p>\r\n<p>In circumstances where debt is utilized to finance real estate, equity investors calculate the equity dividend rate, also referred to as cash-on-cash return, and calculate cash return against cash invested in the first year of investment.<\/p>\r\n<p>The equity dividend rate is arrived at as follows:<\/p>\r\n<p>$$ \\text{equity dividend rate} = \\frac {\\text{year one cash flow}}{\\text{equity}} $$<\/p>\r\n<p>Note:<\/p>\r\n<ol type=\"1\">\r\n<li>The equity dividend rate only covers a single period of analysis instead of IRR, which calculates the entire holding period&#8217;s return. <\/li>\r\n<\/ol>\r\n<blockquote>\r\n<h2>Question<\/h2>\r\n<p>A financier will make an 8% interest-only loan on a property as long as the debt service coverage ratio is at least 1.6 and the loan-to-value ratio does not exceed 60%. What is the maximum loan amount, assuming the property just appraised for $1,800,000 and NOI is $400,000?<\/p>\r\n<ol type=\"A\">\r\n\t<li>$250,000<\/li>\r\n\t<li>$1,080,000<\/li>\r\n\t<li>$3,125,000<\/li>\r\n<\/ol>\r\n<h4>Solution<\/h4>\r\n<p><strong>The correct answer is B.<\/strong><\/p>\r\n<p>Using the DSCR equation:<\/p>\r\n<p>$$ \\begin{align*} \\text{DSCR} &#038;= \\frac {\\text{year one NOI}}{\\text{debt service}} = \\frac {$400,000}{1.6} = $250,000 \\\\\r\n\\text{loan amount} &#038; =\\frac {\\text{DSCR}}{\\text{interest rate}} =\\frac {$250,000}{8\\%} = $3,125,000 \\end{align*} $$<\/p>\r\n<p>Using the LTV ratio:<\/p>\r\n<p>$$ \\text{LTV} = \\frac {\\text{amount of loan}}{\\text{value of appraisal}} $$<\/p>\r\n<p>Substituting for the amount of loan in the equation:<\/p>\r\n<p>$$ \\begin{align*} \\text{loan amount} &#038; =  {\\text{LTV}} \\times \\text{value of appraisal} \\\\ &#038; =  (60\\% \\times $1,800,000) \\\\ &#038; = $1,080,000 \\end{align*}  $$<\/p>\r\n<p>Hence the maximum amount of loan, which is the lower of the two amounts, is $1,080,000. <\/p>\r\n<p><strong>A is incorrect.<\/strong>\u00a0It indicates the DSCR amount.<\/p>\r\n<p><strong>B is incorrect.<\/strong>\u00a0The amount exceeds the LVT ratio of 60%.<\/p>\r\n<\/blockquote>\r\n<p>Reading 36: Investment in Real Estate Through Private Vehicles<\/p>\r\n<p><em>LOS 36 (e) Calculate and interpret financial ratios used to analyze and evaluate private real estate investments.<\/em><\/p>\r\n<p><\/p>","protected":false},"excerpt":{"rendered":"<p>\ufeff\ufeff Debt financiers often prefer debt service coverage ratio (DSCR) and loan to value (LTV) when arriving at the maximum loan on a definite property. $$ \\text{DSCR} = \\frac {\\text{Year one NOI}}{\\text{Debt service}} $$ Where: $$ \\text{Debt service} = (\\text{Interest}&#8230;<\/p>\n","protected":false},"author":4,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[562,102],"tags":[563,216],"class_list":["post-19412","post","type-post","status-publish","format-standard","hentry","category-alternative-investments","category-cfa-level-2","tag-alternative-investments","tag-cfa-level-2","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v26.9 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Real Estate Ratios: DSCR &amp; LTV | CFA L2<\/title>\n<meta name=\"description\" content=\"Learn key real estate ratios including debt service coverage ratio (DSCR), loan to value (LTV), and debt servicing analysis in CFA Level 2.\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, 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