“Hey, George, recently I have heard commercial real estate loan officers talking about some new ratio called the Debt Yield Ratio. \u00a0Is this just a shortened version of the Debt Service Coverage Ratio?”<\/p>\n
Answer: \u00a0No. \u00a0The two ratios are totally different. \u00a0The Debt Yield Ratio<\/strong><\/em> is defined as the Net Operating Income (NOI) divided by the first mortgage debt (loan) amount, times 100%.<\/p>\n Example:<\/strong><\/p>\n Let’s say that a commercial property has a NOI of $437,000 per year, and some conduit lender has been asked to make a new first mortgage loan in the amount of $6,000,000.\u00a0 Four-hundred thirty-seven thousand dollars divided by $6,000,000 is .073.\u00a0 Multiplied by 100% produces a Debt Yield Ratio of 7.3%.<\/p>\n What this means is that the conduit lender would enjoy a 7.3% cash-on-cash return on its money if it foreclosed on the commercial property on Day One.<\/p>\n Please notice that the Debt Yield Ratio does not even look at the cap rate used to value the property.\u00a0 It does not consider the interest rate on the commercial lender’s loan, nor does it factor in the amortization of the lender’s loan; e.g., 20 years versus 25 years.\u00a0 The only factor that the Debt Yield Ratio considers is how large of a loan the commercial lender is advancing compared to the property’s NOI.<\/p>\n This is intentional.\u00a0 Commercial lenders and CMBS investors want to make sure that low interest rates, low caps rates, and high leverage never again push commercial real estate valuations to sky-high levels.<\/p>\n So what is an acceptable Debt Yield Ratio? \u00a0For several years after the Great Recession, 10% was the lowest Debt Yield Ratio that most conduit lenders were using to determine the maximum size of their advances. \u00a0That number has crept down to 9% today and occasionally lower.<\/p>\n In our example above, the subject commercial property generated a NOI of $437,000.\u00a0 Four-hundred thirty-seven dollars divided by 0.10 (10% expressed as a decimal) would suggest a maximum loan amount of $4,370,000.<\/p>\n Typically a Debt Yield Ratio of 9% produces a loan-to-value ratio between 65% and 70%, about the maximum level of leverage that the current CMBS B-piece buyers will allow.<\/p>\n It is the money center banks and investment banks originating fixed-rate, conduit-style commercial loans that are using the new Debt Yield Ratio.\u00a0 Commercial banks, lending for their own portfolio, and most other commercial lenders have not yet adopted the Debt Yield Ratio.<\/p>\n You will notice in my definition of the Debt Yield Ratio that I used as the “debt” just the first mortgage debt.\u00a0 The reason why I threw in the words first mortgage is because more and more new conduit deals involve a mezzanine loan at the time of origination.\u00a0 The existence of a sizable mezzanine loan behind the first mortgage does NOT affect the size of the conduit’s new first mortgage<\/strong>, at least as far as this ratio is concerned.<\/p>\n Will a conduit ever accept a Debt Yield Ratio of less than 9%?\u00a0 Yes, if the property is very attractive, and it is located in a primary market, like Washington, DC; New York; Boston; or Los Angeles – an area where cap rates are exceedingly low (4.5% to 5%) – a conduit lender might consider a Debt Yield as low as 8.0%.<\/p>\n Why did the conduit industry start to use the Debt Yield Ratio? \u00a0For over 50 years commercial real estate lenders determined the maximum size of their commercial mortgage loans using the Debt Service Coverage Ratio.\u00a0 For example, a commercial lender might insist that the Net Operating Income (NOI) of the property be at least 125% of the proposed annual debt service (loan payments).<\/p>\n But then, in the mid-2000’s, a problem started to develop.\u00a0 Bonds investors were ravenous for commercial mortgage-backed securities, driving yields way down.\u00a0 As a result, commercial property owners could regularly obtain long-term, fixed rate conduit loans in the range of 6% to 6.75%, which was stunningly low rate from a historical perspective.<\/p>\n At the same time, dozens of conduits were locked in a bitter battle to win conduit loan business.\u00a0 Each promised to advance more dollars than the other.\u00a0 Loan-to-value ratio’s crept up from 70% to 75% and then to 80% and then up to 82%!\u00a0 Commercial property investors could achieve a historically huge amount of leverage, while locking in a long-term, fixed-rate loan at a very attractive rate.<\/p>\n Not surprisingly, the demand for standard commercial real estate (the four basic food groups<\/strong><\/em> – multifamily, office, retail, industrial)\u00a0soared.\u00a0 Cap rates plummeted, and prices bubbled-up to sky-high levels.<\/p>\n When the buble popped, conduit lenders found that many of their loans were significantly upside down.\u00a0 The borrowers owed far more than the properties were worth.\u00a0 The lenders swore to never let this happen again.\u00a0 The CMBS industry therefore adopted a new financial ratio – the Debt Yield Ratio – to determine the maximum size of their commercial real estate loans.<\/p>\n I had an interesting conversation with a conduit lender this week, and he pointed out that conduit loans are now being priced according to their Debt Yield Ratio. \u00a0For example, the interest rate on an office building loan might be priced at just 170 bps. over swap spreads if the Debt Yield Ratio is 10.0%, but the interest rate would be pegged at 185 bps. over swap spreads if the Debt Yield Ratio was just 9%.<\/p>\n Just a reminder from yesterday’s lesson, the interest rate on conduit loans is now computer based on the greater<\/strong><\/em> of U.S. Treasuries or swap spreads.<\/p>\n<\/div>\n<\/div>\n<\/div>\n<\/div>\n<\/div>\n<\/div>\n","protected":false},"excerpt":{"rendered":" “Hey, George, recently I have heard commercial real estate loan officers talking about some new ratio called the Debt Yield…<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[15,1],"tags":[47,48],"class_list":["post-415","post","type-post","status-publish","format-standard","hentry","category-financial-insights","category-latest-news","tag-ratio","tag-yield","entry","double"],"_links":{"self":[{"href":"http:\/\/streamapse.com\/TAR\/index.php?rest_route=\/wp\/v2\/posts\/415","targetHints":{"allow":["GET"]}}],"collection":[{"href":"http:\/\/streamapse.com\/TAR\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"http:\/\/streamapse.com\/TAR\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"http:\/\/streamapse.com\/TAR\/index.php?rest_route=\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"http:\/\/streamapse.com\/TAR\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=415"}],"version-history":[{"count":1,"href":"http:\/\/streamapse.com\/TAR\/index.php?rest_route=\/wp\/v2\/posts\/415\/revisions"}],"predecessor-version":[{"id":17703,"href":"http:\/\/streamapse.com\/TAR\/index.php?rest_route=\/wp\/v2\/posts\/415\/revisions\/17703"}],"wp:attachment":[{"href":"http:\/\/streamapse.com\/TAR\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=415"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"http:\/\/streamapse.com\/TAR\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=415"},{"taxonomy":"post_tag","embeddable":true,"href":"http:\/\/streamapse.com\/TAR\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=415"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}