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%
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.