Blended Interest Rate – What’s Your True Cost of Capital?

In commercial real estate, capital stacks can involve more than a single layer of debt.  You could have a senior loan, a mezz piece, maybe even preferred equity – with each piece having its own terms.  So how do you figure out the true cost of capital? 

Example: 

ABC Corp is acquiring a 96,250 square foot commercial building.  The project is being financed with two sources:  1) Senior Loan: $25,000,000, 6.75% interest rate, interest-only, 2-year term, 1% origination fee and 2) Mezz Loan: $5,000,000, 13% interest rate, interest-only, 2-year term, 2% origination fee.

See the loan schedule below, the borrower’s initial cash inflow for the senior loan is the loan amount less the origination fee ($25,000,000 - $250,000 = $24,750,000).  The monthly interest-only payments are $140,625 ($25,000,000 x 6.75%/12).  Do this with the mezz loan and sum the initial fundings and interest payments over time for both loans to arrive at total borrower cash flow.  Now we can use the XIRR function to calculate the blended rate of 8.76%

This will provide a much clearer picture of the true cost of capital, incorporating timing of payments, and helps when comparing stacked financing with an alternative single-source loan – providing an apples-to-apples comparison.