Question

You plan to buy 125 acres that has just come up for sale for $16,300/ac. The farm is irrigated, 100% tillable, and your lender will finance a maximum of 50% LTV at 6.25% interest with semi-annual payments for 20 years and a DSCR of no less than 1.05. You and your lender agree that NOI equal to $78,750/year on average is doable. Answer the following questions:

a. What is the maximum you can borrow based solely on the lender's DSCR requirement?
b. What is the minimum the farm would need to appraise for based on the maximum loan amount from 1a?
c. What is the maximum you can borrow based on the lender’s LTV requirement?
d. To pay $16,300/acre, how much do you have to put down and how much can you finance?
e. Calculate the actual DSCR and LTV if you pay $16,300 per acre, putting down the amount from 1d above and financing the balance under the lender’s terms.
f. At what price per acre does the DSCR = 1.05 and the LTV = 50% exactly?

Answer 1

The student's questions involve calculating maximum borrowing limits and down payment requirements based on DSCR and LTV ratios set by a lender for the purchase of a farm. The calculations use formulas for annuity present value, interest rates, and percentage ratios to determine loan amounts and property appraisal values.

Step-by-step explanation:

The student is presented with a scenario involving the purchase of a farm and interactions with a lender. The lender's requirements impose a debt service coverage ratio (DSCR) and loan-to-value (LTV) limits. Below are the answers to the student's questions based on financial formulas and the given information:

a. Maximum Borrowing Based on Lender's DSCR Requirement

Debt service coverage ratio (DSCR) is calculated by dividing net operating income (NOI) by the annual debt service. For a minimum DSCR of 1.05 and a NOI of $78,750, the maximum annual debt service allowed is $78,750 / 1.05 = $75,000. Assume that the debt service is divided evenly between the two semi-annual payments. Since the interest rate is 6.25% per annum, we can use the present value of an annuity formula to find the maximum loan amount that corresponds to a semi-annual payment that, over 20 years (40 payments), would equate to an annual debt service of $75,000.

b. Minimum Farm Appraisal Based on Maximum Loan from a

The loan-to-value (LTV) ratio expresses the loan amount as a percentage of the appraised value of the property. Since we've calculated the maximum you can borrow based on the lender's DSCR requirement in part a, we can establish the minimum appraisal value by dividing that loan amount by 0.50 (50% LTV).

c. Maximum Borrowing Based on Lender's LTV Requirement

As per the lender's LTV requirement of 50%, the maximum loan is equal to 50% of the value of the land. At $16,300 per acre for 125 acres, the total value is $16,300 x 125 acres. Therefore, 50% of the total value is the maximum loan you can borrow under the LTV requirement.

d. Down Payment and Amount Financed at $16,300/Acre

To buy the farm at $16,300 per acre for 125 acres, the total cost is $16,300 x 125. With a financing limit of 50% based on the LTV requirement, the amount financed would be 50% of the total cost, and the remainder would be the down payment.

e. Actual DSCR and LTV Calculation

If you buy at $16,300 per acre, we calculate the actual DSCR by dividing the NOI by the total annual loan payment. The LTV is calculated by dividing the loan amount by the total cost of the farm.

f. Price per Acre for DSCR = 1.05 and LTV = 50%

Setting the DSCR to 1.05 and LTV to 50%, we use the NOI to calculate the annual debt service and then use the LTV to determine the total appraised value of the farm, from which we derive the price per acre.