Commercial Mortgage Lenders: Debt Yield and Mortgage Constant
Debt yield, the ratio between property NOI and loan amount, has become a primary underwriting characteristic for commercial mortgage lenders. Interestingly, debt yield does not take amortization into account, which plays a factor in the borrower’s ability to make mortgage payments. For example, a property with $900,000 NOI and a $10 million loan request with a 6% interest rate, 20 year amortization has a debt yield of 9% and DCR of 1.05. With 30 year amortization, the debt yield remains 9% and the DCR is 1.25. Mortgage constant, the sister ratio of DCR and an older industry heuristic, captures both of these factors- yield and amortization.
In a related vein, Thomas Falbo of commercial mortgage broker Financial Compound discovered while working on a loan recently, that the best way provide an ‘apples to apples’ comparison of the loan choices for our client was to calculate mortgage constant with the effective interest rate (APY), as opposed to the actual rate. At first we threw out the analysis thinking it was over the top, and then we pulled it out of the garbage can realizing the brilliance of it, dubbing this “the Falbo Quotient”. The Falbo Quotient not only accounts for yield and amortization, but also up-front fees and closing costs and expresses all of these factors in terms of yield.