You will recall that the Debt Yield Ratio is different from the Debt Service Coverage Ratio. They are two completely different ratios.
The Debt Yield Ratio is defined as the Net Operating Income (NOI) divided by the first mortgage debt (loan) amount, times 100%.
For example, let's say that a commercial property has a NOI of $437,000 per year, and some conduit lender has been asked to make a new first mortgage loan in the amount of $6,000,000. Four-hundred thirty-seven thousand dollars divided by $6,000,000 is .073. If this number is multiplied by 100%, the calculation produces a Debt Yield Ratio of 7.3%.
What this means in real life is that the conduit lender would enjoy a 7.3% cash-on-cash return on its money if it foreclosed on the commercial property on Day One.
Please notice that the Debt Yield Ratio does not even look at the cap rate used to value the property. It does not consider the interest rate on the commercial lender's loan, nor does it factor in the amortization of the lender's loan; e.g., 20 years versus 25 years.
The only factor that the Debt Yield Ratio considers is how large of a loan the commercial lender is advancing compared to the property's NOI. This is intentional. Commercial lenders and CMBS investors want to make sure that low interest rates, low caps rates, and high leverage never again push real estate valuations to sky-high levels.
A CMBS loan originator named StackSource recently sent out a very helpful update on the CMBS markets and on the Debt Yield Ratio currently being used on apartment loans:
"The CMBS market had a rough year in 2020, but (the CMBS market) has strengthened considerably and is ready to compete for loans on stabilized assets nationwide in 2021."
"As a reminder, CMBS stands for Commercial Mortgage Backed Securities, and this type of loan execution offers long-term holders of commercial real estate several advantages: competitive interest rates (George: Not much higher than the rates from life companies), non-recourse loans, and the potential for interest-only payments."
George: A good way to think about CMBS loans is to call them scratch-and-dent life company loans. They might have qualified for a life company loan, but the property was a little too old, it was in a secondary location (not the single best location in a football team city), and/or it had mom-and-pop quality tenants, rather than national near-credit-tenants.
"Multifamily CMBS loans are beating the agencies (Fannie and Freddie) for certain assets today based on lower interest rates and full-term interest-only payments (I/O)."
George: Full-term interest only payments? CMBS lenders beating agency lenders for apartment loans? Wow. For many years, CMBS lenders had trouble competing with agency lenders. Fannie Mae and Freddie Mac have always offered terrific apartment loans, but these agency lenders were never known for offering the absolute largest loan amounts.
"The ideal scenario is up to 70% for full-term I/O or 75% with amortization. A minimum debt yield of 7.5% (or 8.0% for smaller markets) for apartments will apply."
"Interest rates on apartment loans for full-term I/O will be around 3.00-3.55%, based on today's spreads."
George: With interest rates this low and interest-only payments, apartment investors much be raking in cash flow hand-over-fist."
"CMBS is even coming back for hotel financing, granted at a lower leverage point (60% LTV, 12% Debt Yield) and at relatively higher rates in the 4's."
George: As long as the loan is larger than $5 million, it might even make sense to work on hotel loans again.