Debt Yield and Debt Yield Minimums Explained
In general, the minimum debt yield for a commercial real estate loan is around 10%. Some lenders, however, place their minimum debt yield requirements as low as 8%, while others require debt yields of up to 12%.
Debt yield minimums are higher for higher-risk asset classes and lower for lower-risk asset classes. Common debt yields for different asset classes include:
Multifamily: 8%
Office: 10%
Retail: 10%
Industrial: 8%
Hospitality: 12%-14%
What is Debt Yield?
The debt yield of a property is calculated by taking the property’s Net Operating Income (NOI), by the entire amount of the loan.
For example, if a property had an NOI of $300,000 with a total loan amount of $2 million, the debt yield would be 15%.
The debt yield represents the cash-on-cash return that a lender would receive if it foreclosed on a property today.
Why Debt Yield is So Important to Lenders
In hot real estate markets, a variety of factors can distort the risk to reward ratio for lenders wishing to provide loans backed by commercial or multifamily real estate. These include:
Abnormally high property values
Long amortization periods
Higher leverage
Low-interest rates
Debt yield does not factor in any of these elements, and can therefore be considered a more reliable metric when it comes to calculating lender risk.
Easy availability of loans increases the liquidity of the market, which may also lead to increased real estate prices. This, as occurred in 2008, can create a cycle that leads to constantly increasing prices, and eventually a crash. By lending based on debt yield rather than other factors, a lender can limit their risk and help contain market exuberance.
Debt Yield and CMBS Financing
CMBS lenders generally focus on debt yield far more than other types of lenders. This is because CMBS loans, also referred to as conduit loans, are securitized and pooled together into bonds called commercial mortgage-backed securities. The entity issuing the security has promised the investors in the bond that they will receive a certain interest rate per year, and unlike a private lender, which can afford to quietly take a loss, the default of a property backing a CMBS bond can adversely impact its rating, and therefore the reputation of the bond issuer.
Therefore, keeping debt yields high ensures that the bond issuer (or, in reality, the special servicer) can provide the investors the cash flow they’ve promised, even if the borrower of property defaults and they need to repossess it.