I know we have a blog post discussing Debt Yield, but I think it is important to readdress the topic in greater depth.
As we move forward from the pandemic and life begins to return to “normal” or however you want to define it. Small Balance Commercial (SBC) lenders will be utilizing all of the possible metrics and analysis for potential loans. One of the more popular methods since the “Great Recession” that SBC lenders use is Debt Yield. Remember, debt yield is a metric used to determine the risk of a proposed loan.
The formula is:
Debt Yield= Net Operating Income (NOI)/ Loan Amount
Generally, ten percent (10%) is considered the minimum Debt Yield an SBC lender would require for a loan. Essentially, the lower the Debt Yield the higher the lender’s risk.
The attraction of SBC lenders to utilize Debt Yield, is that it is calculated without relying on a capitalization rate (Cap Rate), interest rate, or amortization period, all of which can easily be adjusted (within reason) to result in a desired outcome.
Keep in mind, this is only one of many underwriting calculations that an SBC lender will analyze before approving any potential loan. Other metrics include Loan-to-Value (“LTV”) and Debt Service Coverage Ratio (“DSCR”). In a past blog, we examined how a change from a 25-year amortization period to a 20-year amortization period can greatly impact the DSCR or how a small adjustment to a Cap Rate can impact the value of a property.
As such, most SBC loans must meet the minimum threshold for all three categories: Debt Yield, LTV and DSCR. Each SBC lender may have different requirements for the three metrics along with other underwriting requirements (i.e. borrower credit, property type, etc.), so make sure you understand their program requirements before submitting a loan for approval.
Debt Yield in Conclusion
Debt Yield provides an SBC lender a measure of risk independent of interest rates and Cap Rates. Given the current low interest rate environment, Debt Yield provides an additional measure of a property’s likelihood to repay a loan using the Net Operating Income.
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