Debt Yield in Relation to CMBS Loans
When it comes to CMBS loan underwriting, DSCR and LTV aren’t the only factors that a lender considers. Increasing, lenders are looking at a another metric, debt yield, in order to determine whether it’s truly worth approving a borrower for a conduit loan. Debt yield can be determined by taking a property’s net operating income (NOI), dividing it by the loan amount, and multiplying it by 100.
CMBS Loans and Debt Yield Requirements
When it comes to CMBS loan underwriting, DSCR and LTV aren’t the only factors that a lender considers. Increasing, lenders are looking at a another metric, debt yield, in order to determine whether it’s truly worth approving a borrower for a conduit loan. Debt yield can be determined by taking a property’s net operating income (NOI), dividing it by the loan amount, and multiplying it by 100. For example, if a property had a net operating income of $500,000 a year, and a borrower wanted to take out a $5 million loan, the debt yield would be:
$500,000/$5,000,000 = 0.1 * 100 = 10%
Debt Yield Calculator
What is the Required Debt Yield for Conduit Loans?
In the past, many conduit lenders required a 9 or 10% debt yield before agreeing to approve a loan. However, in today’s market, CMBS lenders are hungry for borrowers, which means that most are now willing to accept lower debt yields, often around 7%. Lenders are more likely to accept lower debt yields if a property is in a highly desirable market, such as New York City, or Los Angeles, but may have stricter requirements if a property is in a less desirable second or third-tier market.
Unlike other metrics, debt yield doesn’t look at interest rates, amortizations, or other factors— all it does is show exactly how much income a lender would be able to get if a property was foreclosed on immediately— and this is exactly why lenders want to use it. Partially, this is a result of overly relaxed conduit lending standards during the real estate bubble of the mid 2000s. As property values skyrocketed, conduit lenders allowed LTVs to reach well above 80%, but when the market crashed, many CMBS borrowers found themselves underwater on their loans, resulting in a huge swath of foreclosures.
Do Mezzanine Loans Affect Debt Yield Calculations?
No. Debt yield is only determined by looking at the amount of the first mortgage. Mezzanine loans, even if originated simultaneously with CMBS senior debt, don’t affect a borrower’s debt yield. Likewise, preferred equity, since it is not technically debt, also does not affect debt yield.
Related Questions
What is net operating income (NOI)?
- Net operating income, or NOI, is a metric used to calculate the profitability of an apartment property. More specifically, NOI determines the profit or loss of an investment property after subtracting all operating expenses.Learn more →
What is the difference between debt yield and loan-to-value ratio when it comes to CMBS loans?
The difference between debt yield and loan-to-value ratio when it comes to CMBS loans is that debt yield is a metric used to measure the cash flow of a property relative to the loan amount, while loan-to-value ratio is a metric used to measure the loan amount relative to the value of the property.
Debt yield is currently not as popular as other metrics that determine the viability of a property for commercial or multifamily lenders, but CMBS lenders put a great deal of stock in this metric. This is partially because conduit lenders took serious losses during the last real estate bubble, when they relied on metrics like LTV, which fell quickly as property values rose. This led them to over-lend significantly, leading many to close when the bubble burst. Plus, nearly all conduit loans are non-recourse, so CMBS lender generally can’t go after a borrower’s personal assets in order to recoup their losses.
For CMBS loans, debt yield is typically calculated by dividing the net operating income (NOI) of a property by the loan amount. The higher the debt yield, the more likely the loan is to be approved. Generally, CMBS lenders require a debt yield of at least 8.5%.
Loan-to-value ratio, on the other hand, is a metric used to measure the loan amount relative to the value of the property. It is calculated by dividing the loan amount by the appraised value of the property. Generally, CMBS lenders require a loan-to-value ratio of no more than 75%.
How does debt yield affect the interest rate of a CMBS loan?
Debt yield is a metric used by CMBS lenders to determine the interest rate of a loan. The debt yield ratio is calculated by dividing the net operating income (NOI) of a property by the loan amount. The higher the debt yield, the lower the interest rate. For example, a debt yield of 8% would typically result in an interest rate of 4.5%.
The debt yield ratio is important to CMBS lenders because it helps them determine the risk of a loan. A higher debt yield indicates that the loan is less risky, and therefore the interest rate is lower. Conversely, a lower debt yield indicates a higher risk loan, and therefore a higher interest rate.
It is important to note that debt yield is only determined by looking at the amount of the first mortgage. Mezzanine loans and preferred equity do not affect a borrower’s debt yield.
What are the advantages of a CMBS loan with a higher debt yield?
CMBS loans can provide the highest leverage loan a borrower can get for properties in secondary and tertiary markets. Additionally, CMBS loans are non-recourse, meaning a CMBS lender generally can’t go after a borrower’s personal assets to recoup losses on a defaulted note. This can be a great advantage for borrowers who are looking for a loan with a higher debt yield.
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What are the risks associated with a CMBS loan with a lower debt yield?
The risks associated with a CMBS loan with a lower debt yield are that the lender may not be able to recoup their losses if the loan defaults. This is because the debt yield ratio is a measure of how much income a lender would be able to get if a property was foreclosed on immediately. If the debt yield is too low, the lender may not be able to recoup their losses. Additionally, since most conduit loans are non-recourse, the lender may not be able to go after a borrower’s personal assets in order to recoup their losses.
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What are the most important factors to consider when evaluating a CMBS loan's debt yield?
CMBS lenders put a great deal of stock in the debt yield ratio metric. This metric is used to measure the amount of income generated by a property relative to the amount of debt used to finance it. The debt yield ratio is calculated by dividing the net operating income (NOI) of a property by the total loan amount. A higher debt yield ratio indicates a lower risk of default for the lender.
In addition to the debt yield ratio, CMBS lenders also consider other factors when evaluating a loan, such as the loan-to-value (LTV) ratio, the debt service coverage ratio (DSCR), and the loan term. The LTV ratio is used to measure the amount of debt used to finance a property relative to its value. The DSCR is used to measure the amount of income generated by a property relative to the amount of debt used to finance it. The loan term is used to measure the length of time a loan is in effect.
Overall, the most important factors to consider when evaluating a CMBS loan's debt yield are the debt yield ratio, the LTV ratio, the DSCR, and the loan term.