Below Market Financing and Value

Below Market Financing and Value

A real estate investor is considering the purchase of a shopping center. The project has an expected annual net operating income of $100,000. He expects a selling price of $900,000 at the end of five years. The investor has two financing options for a $700,000 (interest only) mortgage:

1. market financing at 10% for 5 years

2. seller financing at 8% for 5 years

The investor has a required rate of return of 12%. How much will be pay for this property under the two financing options?

Market financing:

Seller financing:

The investor is better off with the seller financing as long as the price is less than $972,096. At a price of $970,000 his return will exceed the 12% resulting in a positive NPV. The value of the below market financing is the difference in values: $50,467.