Hi Everyone,
I'm currently working on a case study and was wondering if anyone could help me out on the below debt sizing assumptions:
Min DY: 10.0%
Min DSCR: 1.3x
Min LTV: 70.0%
Benchmark: 3.040%
Spread: S + 180 bps
Amortization: 25 Years
Interest Only: None
What does the benchmark assumption refer to in this case study and how would I use it in my model?
Thanks in advance.
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I'd assume that is the meant to be swaps benchmark for finding the interest rate to use for modeling. Unless you have that quoted elsewhere, only thing that makes sense given what you posted.
I got some clarification and I think you're right! The rates weren't quoted in the case study so do you know what the best method for using the benchmark to look up what the Swap rate is?
If it is the "swaps" rate to use, then just add 180 bps to it to get your interest rate for modeling purposes.
Edit: Deleted as I meant to make this a response and not a new post
Most likely the benchmark may be referring to the floor of interest rate (i.e lowest it could possibly go). This is to hedge for when the indices are extremely low especially SOFR which is near 0%. Depending on how much time you have on the case study you might be able to reach out to clarify. As long as you put in some thought and you have a rough understanding of whats going on I'm sure they'll point you in the right direction.
Yeah, I also thought this was a possibility. They gave me a week to do it so I think it'll be okay to reach out to get some clarity. Thank you for your input!
Yeah I would ask if thats meant to be the interest floor or if it's the value for SOFR you are supposed to be using (although a >4.5% interest is p high, but may just be for case study purposes)
Benchmark does not refer to a floor. A floor is / would be called a floor. A benchmark can go to zero, or even below zero, that is why you have a floor on your total rate or on your benchmark. For instance, in much of 2019 and early 2020, banks were quoting floating rate loans over Libor with a floor of 0% for the institutional debt markets. A benchmark is what you price over. So a benchmark of SOFR, or LIRBOR, or Treasuries. And you do the spread plus the benchmark (taking into account if a floor is noted) gets to the total rate.
Benchmark + spread = rate. So the "S" stands for swaps. You can get rates at the Chatham Financial website. Current ten year swap is 1.092%. I would ask which swap should you be looking for but honestly, they probably don't care - they just want to see that you know it. (Chatham Website: https://www.chathamfinancial.com/technology/us-market-rates). You generally see rates listed as Treasury +, Swaps +, or Libor +. So in your model, I would make a row called benchmark and input the swap rate, than a row called spread and do do 1.80%, and add the two together and you get your interest rate.
Wow, I might go and guess pudding is CashPoorCapital on instagram!
Thank you so much for the thorough explanation!
If possible, would you be also be able to explain this portion of the debt sizing assumptions?
Min DY: 10.0%
Min DSCR (amort): 1.3x
Min LTV: 70.0%
It's for a refi and I know this means that these are the metrics used to determine what the maximum loan amount the lender is willing to give out. I only have experience using the LTV as a metric to determine the loan amount in deals that I've worked on so in this case study, do I need to account for all 3 of these metrics to determine the loan size? And if so, how does that work?
Sure...so for the tests:
Min Debt Yield: 10%: Debt yield is NOI divided by the loan amount. So..the NOI divided by the loan amount must be 10%. If the property NOI is $100,000, and the loan amount is $700,000, than the debt yield is $100,000/$700,000=14.28%. To solve for a 10% debt yield, at $100,000 NOI, the loan balance can be $1,000,000. Debt yield is essentially the cap rate calculated on the lender's basis (loan amount).
Min DSCR: Debt service coverage ratio is NOI divided by the annual debt service. In this instance, we only know the minimum DSCR and our assumed NOI.
Formula: (NOI/DSCR=Max Loan Payment). Think of this like algebra, we have two of the three variables. We have the DSCR and let's assume NOI is $100,000. So we can solve for Max Loan Payment. If you do NOI divided by your DSCR, so let's assumed $100,000 / 1.3 = $76,923.07. This is your max loan payment (debt service). Now that you have this, if you know the rate, and the amortization, you can determine the loan balance with the Present value (PV) function in excel.
Min LTV: If the purchase price (or DCF value) is $1,000,000, the Purchase Price * Min LTV = $1,000,000*70%= Max Loan Amount (Under this methodology). So the max loan with this test is $700,000.
Now that you have these three steps, to get the loan amount with this information. You need to calculate the loan amount each one produces and take the lowest one. So minimum debt yield produces, in our example, $1,000,000 loan. Minimum DSCR you need to solve for. And the Min LTV test produces a loan of $700,000. So once you find the minimum DSCR loan amount, you can take the lowest one, and that will be the loan amount you use.
This is good practice to do as loan term sheets will usually size a loan based on restrictions. This is to protect themselves. For instance, purchase price of the deal is $100,000,000. Lender says great, I'll give you 70% LTV. But what if the value comes back at $110,000,000. The lender will give more. Or alternatively, the value on the appraisal comes back at $90,000,000, the lender want F**k up protection so they don't over lend on an asset. That is also why they put the extra tests in too, so they will look at debt yield, DSCR, and LTV or LTC. Hope that helps. Let me know if you have any other questions.
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