How do lenders determine what the debt service is in their DSCR sizing, particularly on floating rate debt? Do they use the LIBOR curve to project debt service, or are there other, more conservative methods?
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They have a proxy or stress test rate. They'll underwrite a 1yr ARM at 4%, for example, at 6 or even 7%. Wells Fargo is currently underwriting with a proxy rate of 7% even on fixed rate deals.
Lol, typical WF. Most lenders have been using 6-6.5% like you said
As said above, floating rate debt uses a higher interest rate than LIBOR projections to stress the project and ensure it could still pay debt service if rates began to rise drastically. These have typically been in the 5.5 to 7% range over the last few years depending on the lender. However for well qualified sponsors, the DCR only needs to be 1.0 - 1.1 on the floating rate side compared to 1.25+ on the fixed rate side. When UW floating rate debt, I use a recent LIBOR curve to project proforma debt service, but a separate stress rate for sizing.
That is not the reason they test on a fixed basis. The reason they test on a fixed basis is to make sure that the takeout lender will be able to refinance them at the required DSCR at stabilization. Interest rate caps exist and are required by most lenders to mitigate the risk of rates spiking.
can you elaborate on what a "takeout" lender is and what their role in the process is?
Bridge Deal (SUPER GENERIC EXAMPLE): Step 1: Get floating rate bridge loan to complete your turnaround business plan, renovation etc. Usually quoted on LTC, or stabilized debt yield. Usually 2-3 year deals with 1-2 extension options. Step 2: Execute your plan Step 3: At the end of the bridge loan, hopefully, you didn't fuck up and your property is where you projected it would get to. If this is the case, you get a permanent (5-10 year) fixed rate loan to "take out" the bridge lender. Hence the term takeout, it's just semantics. In some cases your takeout lender will be another bridge lender because your property is still not doing well, in which case, you drank your own kool aid and god speed!
What about a floating rate agency acquisition loan? Are those sized differently?
Agency is so cookie cutter you can find the terms for their all of their programs online. They all work under strict guidelines so they can't really stray from those.
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