Why does DY matter to Lenders?
Sorry might be a stupid question but debt is not my expertise.
Why do lenders care so much about debt yield? Shouldn’t LTV and DSCR (ability for borrow to repay debt service) be the really only two metrics? Why would I care what my yield is on a loan if I am not technically getting any of that NOI? If the DY is only say 6% but they have sufficient CF to repay me, why would I care?
Debt Yield is primarily used by cmbs lenders, and from my understanding debt yield is used because low interest rates and cap rate compression have skewed dscr. You can engineer dscr w/ cap rate and amortization periods; since debt yield is just noi/loan amount it's not as affected by cap rates, interest rates, amortization periods, etc.
^this. You can manipulate dscr depending on the amortization period you choose ( 10 yrs, 20 yrs, 30yrs)
Debt yield is used by many life co’s and banks as well. Both of these will sometimes tie loan tests for value add properties to debt yield.
for the original poster: debt yield became important post 2008 financial crisis. It is the loan’s ‘cap rate.’ Therefore, if the borrower defaulted, the lender will get the property back at their debt yield (cap rate).
For instance, your coverage ratio could be 1.05x, but your debt yield may be 4%. If the property stabilizes at 1.25x and than the debt yield is only 5.5%, sure you’re covering the loan, but what if the market cap rate is 5.75%? Well if the borrower defaults, the lender will lose money on their principal balance because the property is worth less than the loan.
It is just another metric for lenders to look at. It represents the cap rate the lender "buys into" if the loan defaults and the lender has to take over the property.
Ah, now that makes sense. Never thought about it from the side of defaulting and a lender taking over. Thank you!
It came back into vogue after 2008. DY is the cash yield the bank would enjoy were it to take over the property. Obviously, the NOI is going to go to hell if the borrower defaults, but it is still a useful tool. It is a way to relate the size of the loan to the cash flow, without being skewed by interest rates and valuation. It is also worth noting that most banks don't even use actual DSCR, they use a risk rating interest rate (which is standardized) and judge DSCR vs that.
Also it is also used to measure exit risk. DY is the max interest rate the current loan could be refinanced for.
Helpful measure in an increasing interest rate environment.
http://essexfg.com/uploads/2014-02-19-crej-debtyield.pdf
More info here too
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