Size Up Your Loan

Let’s size up your loan for your next acquisition:

Getting debt quotes from commercial lenders can take days or even weeks. Sometimes you can’t wait that long. To quickly ballpark the financing terms your deal will qualify for, here are a few key metrics that lenders use to size a loan and how to calculate them.

1. Debt Yield

What do commercial mortgage lenders care most about when making a loan? Making sure they get the principal paid back! That’s why the debt yield calculation is such an important metric for lenders to look at.

Lenders will have internal debt yield targets they will abide by. Most lenders will want to see a debt yield of 6% or higher.

Loan Amount = Net Operating Income ÷ Debt Yield

The difficult part here is determining the NOI. What is the right stabilized net operating income? Is it what the broker is telling you? Is it your Year 1 NOI? What about the trailing 12 months? The lender will do their own analysis to calculate the NOI so this will take some intuition on your side for a preliminary analysis.


2. DSCR

This DSCR test sizes the loan based on the minimum required debt service coverage ratio based on the lender’s internal requirements.

The DSCR is the number of times that the property’s adjusted NOI must “cover” the annual debt service (both principal and interest payments combined).

Lenders want to be certain there is enough ‘cushion’ from the property’s cash flows to account for any NOI fluctuations.

DSCR Test: NOI / Required DSCR = Annual Loan Payment

Then use the Present Value function in Excel:

Loan Amount =-PV(interest rate, nper, Annual Loan Payment/12)


3. Loan to Value

The lender will size the loan based on the value of the property. Keep in mind, the ‘value’ can be different than the purchase price.

This test is based on the value of the property related to its adjusted NOI (net operating income after reserves). The lender will apply a cap rate to the trailing 12 month’s worth of adjusted NOI, deriving a property value.

Assuming the property will appraise to this value, the lender will then apply their (credit committee-given) maximum Loan to Value percentage (example: 70%) to size the loan.

Loan Amount = Value x Max LTV