Debt Yield Ratio on Commercial Real Estate Loans

Debt YieldQ:  Carmen, your terms look competitive, the only question I have is on the “Debt Yield”.  Is this the interest rate?

A:  The Debt Yield is not the interest rate.  The Debt Yield Ratio is defined as the Net Operating Income (NOI) divided by the mortgage loan amount, times 100.  It is usually a calculation commercial and CMBS lenders do to figure out the cash on cash return on its money loaned. For example, let’s say that the NOI of a commercial property is $500,000 per year, and the mortgage loan amount is $6,000,000. The Debt Yield Ratio would be 8.3%. This means that if the lender were to foreclose on the first day it would enjoy an annual cash on cash return of 8.3% on its money.

An acceptable Debt Yield Ratio is at 10% or above. Some lenders make exceptions based on the location and class property. While strong markets justify exceptions the average Debt Yield Ratio nowadays still remains at 10%. In our example above, the subject commercial property generated a NOI of $500,000. Five-hundred  thousand dollars divided by 0.10 (10% expressed as a decimal) would suggest a maximum loan amount of $5,000,000.

Typically a Debt Yield Ratio of 10% produces a loan-to-value (LTV) ratio between 63% and 70%. This is the maximum level of leverage that the current CMBS lender will agree to on B class properties.

The Debt Yield Ratio does not take in consideration the Cap Rate, the Term of the Loan, the Interest Rate, or the Amortization. That is because lenders want to make sure that low interest rates, low caps rates, and high leverage don’t prompt real estate valuations to bubble levels. 

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