Which test sets the loan: LTV, DSCR or debt yield
At today's rates, coverage usually sets the loan. In low cap rate markets, debt yield binds first. How to tell which governs your file before you go to market.
- Three tests size a permanent loan: LTV on value, DSCR on the payment and debt yield on income. The lowest answer is the loan.
- With the 10-year Treasury above 5%, coverage usually sets the loan on a stabilized acquisition before leverage does.
- Debt yield binds first when cap rates are low: at 75% LTV and an 8% floor, any cap rate under 6% hands the loan to debt yield.
- Fannie Mae and Freddie Mac size on DSCR and LTV. Debt yield floors matter most for CMBS, life companies and debt funds.
The old assumption
For years, LTV was the number that governed an acquisition. Sponsors and brokers priced deals against a max-LTV grid, and the rest of the underwriting followed from there. That still shapes how a lot of files get shopped, and at today's rates it is usually the wrong place to start.
What governs at today's rates
A permanent lender runs three tests and lends the lowest answer. With coupons near 7%, the payment is the expensive part, so the coverage test tends to cap the loan first. Take an illustrative stabilized acquisition: $1,000,000 of NOI at a 5.5% cap rate, so a value of $18.2M, with a 6.90% coupon on 30-year amortization.
Coverage wins by more than $2M. At the $10.1M loan the debt yield is 9.9% and leverage is 56%, so neither of the other tests is close. Lower the coupon, add an interest-only period or raise the NOI, and coverage loosens; that is when debt yield starts to bind instead.
Where debt yield binds first
Debt yield caps the loan before LTV when the cap rate is below LTV times the floor. At 75% LTV and an 8% floor, that line is a 6% cap rate. Newer multi-family and industrial in low cap rate markets sit under it, and so do loans with interest-only periods, where the payment is light and the coverage test is easy to pass. CMBS lenders, life companies and debt funds carry debt yield floors; Fannie Mae and Freddie Mac size on coverage and leverage.
What to check before you go to market
Run all three before you quote a number to a sponsor: in-place NOI against the payment at today's coupon, NOI over the loan against each source's floor, and the loan over value. The test that comes back lowest is the loan. The LTV quoted on a first call is rarely the number in the term sheet.
"We run LTV, DSCR and debt yield on every file before a lender sees it, and we give the sponsor the lowest of the three."
How this changes deal structuring
When coverage or debt yield governs, the lever that moves proceeds is NOI, not a better leverage quote. Sponsors who can document higher in-place income (a lease-up, a rent increase already signed, expense recoveries not yet in the T-12) can push proceeds further than one who shops harder for leverage. Put that evidence in the file before it goes out.
The rate tables on each Capital Markets page show the live coverage and debt yield floors by source, with today's index.