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8% is payment in kind / PIK. Principal balance increases by 8% p.a. (Then the next year that balance by 8% and so on) while you also clip 8% in cash interest
Accrued isn't always PIK. You can have 8% current and 8% accrue without the principal balance increasing
Accrue by definition means accrue to the principal balance. If it is accruing, the principal is growing. The above is inaccurate unless the terms are terribly worded.
^ What was said about Payment in Kind / PIK.
Imagine the complete opposite of amortisation, capital added back onto the loan instead of deducted from.
This is called negative arbitrage
Can you provide an easy example (For a real estate deal)? Thank you.
Yeah if you had a $100 loan, you’d pay $8 a year in current interest - actual cash out the door to the lender. You’d also accrue $8 of interest over that same time period, so your balance at the end of the year would be $108 and you would’ve paid out an additional $8.
Is this essentially it? 10% Pref Equity (5% current and 5% accrual) - $100,000 for 3 Years.
Current Pay:
Year 1: $5,000
Year 2: $5,000
Year 3: $5,000
Year 3 (Accrual): $15,000
Total Return ($): $30,000
In 99% of cases the above wouldn't be correct (some companies/people/regions might do calcs on what is called a 'fee simple' basis which will look like your workings) - See below for industry standard;
Year 1: $5,000 ($100,000 balance)
Year 2: $5,250 ($105,000 balance)
Year 3: $5,512.50 ($110,250 balance)
End Year 3 (Accrual): $15,762.50
Total Return ($): $31,525
You pay a 5% coupon on your current balance but your balance is also increasing by 5% pa.
Correct
Thank you - So are you actually getting paid that current, annual cash flow or does it just rack up and accumulate?
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