 # Level II has an interview question, I can't answer

A commercial property was priced at 15 times net operating income (cap rate of 8%). For an investor who required a 10% ROE and can borrow at 5% (80% LTV), what is the expected growth rate for operating income? Could anyone please share with me how you solve the problem? Thank you.

I think you may have to use the band of investment method to work out a cost of equity and debt capital or required return given leverage is used to purchase the property. This amount (say R) less the growth rate (g) equals the 8% cap rate ®.

It may actually be simpler as mortgage is not amortising and you have no other details. In this instance the required return would be 6%, leading to a growth rate of -2%.

Wouldn’t it be more like: R = r-g r=10% R=8% g=+2%? I am a little rusty on this topic

Shuzen, you asked the same question in L2 forum and there was an answer similar to that os “artvandalay” Marketcapitalization rate = discount rate +/- depreciation/appreciation. Here r=10, capitalization rate is 8 8 = 10 +/- depreciation/appreciation since 8<10, it is a growth rate of 2