What is Debt Yield?
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In multifamily finance, one of the most important metrics would be a property’s debt yield. Debt yield is taken into consideration by lenders in order to understand how long it would take for them to recoup their investment if they had to take possession of a property after a loan default. In order to determine the debt yield, you take a property’s net operating income (NOI) and divide it by the total loan amount. So for example, if a commercial property’s net operating income was $200,000 and the entire loan amount was $1,500,000, the debt yield would be $200,000 divided by $1,500,000 which equals 0.133 or 13.33%.
It isn't uncommon to find multifamily lenders who now require a minimum debt yield in order to approve a loan, meaning it’s also possible to calculate the maximum loan amount, so long as you know the annual income of a property. For example, using the example NOI above, if a lender had a minimum debt yield requirement of 12%, a borrower would be able to take a loan out of up to $1.66 million (as long as that amount was consistent with other factors, like LTV and DSCR).
$200,000/0.12 = $1,666,666
Extrapolating this data would show that a debt yield of 12% would mean that it would take a lender roughly 8.3 years to recoup their losses, assuming the property isn't sold beforehand, NOI did not increase, and the borrower defaulted immediately.
Debt Yield in Comparison to DSCR, LTV, and Cap Rate
Risk metrics like Debt service coverage ratio (DSCR) can easily be skewed by low interest rates and long amortizations, while the debt yield metric remains the same, no matter what a borrower’s "monthly's" look like. In this sense, a debt yield can be a better method to gauge the true risk of a loan, as well as to compare it to other loans on similar apartment properties. While debt yield requirements tend to vary, most lenders prefer debt yields of 10% or higher. For premium properties located in top-tier markets, however, say, for example New York City or Los Angeles, many lenders may be willing to accept debt yields as low as 9%, or even 8% at their discretion, often in highly exceptional circumstances.
Another important metric lenders consider for nearly every apartment loan transaction, LTV, does not change based on the specifics of a loan, but it can vary greatly based on market conditions. For example, if apartment property prices spike (such as they did back in the early 2000s), a property’s LTV ratio could decrease significantly, without the actual risk for the lender falling that much. For example, an $800,000 loan for a property that has been valued at $800,000 would have an LTV ratio of 100% and thus be considered highly risky. However, if, over a 1-2 year period, the property value increased to $1 million, the LTV would fall to 80%, which is considered a reasonable risk for many commercial lenders. The circumstances surrounding the dramatic drop in LTV were completely out of the hands of borrower and lender alike, and just a side effect of a moving market.
The problem for lenders, as you may now see, is that markets constantly fluctuate, and the market could fall even more in the next 12-24 month period than it rose in the previous one. If the market were to fall by 30%, the LTV on the property in the last example would be 114%, putting it squarely ‘underwater’ and simultaneously putting the lender at significant risk.
On this same note, debt yield is actually very similar to cap rate, but since the cap rate divides a property’s income by its current market value, it’s also susceptible to variations in the market price of a property.
Debt Yield and CMBS Loans
Debt yield is currently not as popular as other metrics that determine the viability of a property for commercial or multifamily lenders. The exception to this, however, can be found with CMBS lenders, who actually put a great deal of stock in this metric. This is partially because most conduit lenders took serious losses during the last real estate bubble in 2008, when they relied on metrics like LTV, which fell quickly as property values rose. This oversight led them to over-lend significantly, leading many bankrupt, closed, and shuttered when the bubble burst. Additionally, nearly all conduit loans are non-recourse, so a CMBS lender generally can’t go after a borrower’s personal assets in order to recoup their losses.
Related Questions
What is the difference between debt yield and debt service coverage ratio?
Debt yield is calculated by dividing a project's NOI by its loan amount and multiplying it by 100 to achieve a percentage. This figure is used to measure a more stable measure of risk for lenders. On the other hand, debt service coverage ratio (DSCR) is calculated by dividing a property’s NOI by its annual debt service. DSCR is used to assess risk in approving a new loan.
Debt yield gives lenders more definitive timeline of recouping their funds in the event of a foreclosure, while DSCR can be manipulated by changing the interest rate used in the mortgage calculation and/or changing the length of the amortization period for the loan.
How does debt yield affect the cost of an apartment loan?
Debt yield is an important metric taken into consideration when financing an apartment property purchase, as it helps lenders to understand how long it would take for them to recoup their investment in the event of a loan default. Most apartment financing options available require a debt yield minimum in order to mitigate risk, which means it’s possible to calculate a potential maximum loan amount for any such financial vehicle, given you know the annual income of the property.
For example, using an example NOI of $500,000, for a loan with a minimum debt yield requirement of 15%, a borrower would be able to take a loan out of up to $3.3 million (as long as that amount was consistent with other factors, like LTV and DSCR).
The higher the debt yield requirement, the higher the cost of the loan. This is because lenders will require a higher return on their investment in order to mitigate their risk. Therefore, borrowers should be aware of the debt yield requirements of the loan product they are considering in order to understand the cost of the loan.
What is the maximum debt yield for an apartment loan?
The maximum debt yield for an apartment loan depends on the lender's minimum debt yield requirement and the property's net operating income (NOI). For example, if a commercial property’s net operating income was $500,000 and the lender had a minimum debt yield requirement of 15%, a borrower would be able to take a loan out of up to $3.33 million (as long as that amount was consistent with other factors, like LTV and DSCR).
**$500,000/0.15 = $3,333,333**
What factors influence the debt yield of an apartment loan?
The debt yield of an apartment loan is influenced by several factors, including the property's net operating income (NOI), the total loan amount, and the loan's minimum debt yield requirement. For example, if a loan has a minimum debt yield requirement of 15%, a borrower would be able to take a loan out of up to $3.3 million (as long as that amount was consistent with other factors, like LTV and DSCR).
Other factors that can influence the debt yield of an apartment loan include the loan's interest rate, the loan's term length, and the borrower's creditworthiness. Additionally, the lender may also take into consideration the property's location, the condition of the property, and the borrower's experience in the real estate industry.
What is the difference between debt yield and loan-to-value ratio?
The difference between debt yield and loan-to-value ratio is that debt yield is a static measurement that is unaffected by changing market valuations, interest rates, and amortization periods, while loan-to-value is a measure of the total loan amount divided by the appraised value of the property. Loan-to-value is subject to manipulation and volatility, while debt yield is a much more accurate way for lenders to ensure a loan amount isn’t subject to inflation caused by low market cap rates, low interest rates, or high amortization periods.