When time does not permit for a detailed loan sizing analysis, a reasonably accurate shortcut method can roughly determine the maximum CMBS conduit loan amount that can be offered to a borrower. The method utilizes a metric called “debt yield,” which is defined as the property net cash flow for the most recent 12 months (including vacancy, management fees and replacement reserves) divided by the proposed loan amount, expressed as a percentage.
For example, if a borrower on a retail center says his most recent net cash flow after expenses is $1 million including a management fee and replacement reserve and the loan request is $10 million, then the debt yield is 10% ($1,000,000 divided by $10,000,000). The result can be compared with the minimum debt yield required for each asset type. If the calculated debt yield exceeds the minimum debt yield, preliminarily, the loan amount is acceptable.
The following are the minimum debt yields for each eligible asset type financed in CMBS:
More important, the debt yield formula can be reworked to indicate the loan amount. Suppose the same borrower in the example above said, “I have net cash flow after expenses of $1 million including a management fee and replacement reserve. How much can you lend me?” The calculation using debt yield would look like this: $1,000,000 (net cash flow) divided by 8.5% (the minimum debt yield for retail properties) equals $11,750,000 (rounded). So the borrower can be offered $11,750,000, which would meet minimum debt-service coverage and maximum loan-to-value requirements.
I often get a skeptical look from folks who are unsure of the accuracy of the debt yield method: What about market cap rates, debt-service coverage, appraised value and other metrics? How can all of these be incorporated into one metric? Well, it simply works.