Key Takeaways
- CMBS loan size is the minimum of LTV, DSCR, and debt yield constraints.
- In low-rate environments, LTV typically binds; in high-rate environments, DSCR often binds.
- A 400 bps rate increase reduces DSCR-constrained loan sizing by approximately 35%.
- Rising rates compress property values because they reduce supportable debt.
CMBS loan sizing is determined by the most restrictive of three constraints: LTV, DSCR, and debt yield. This lesson walks through the loan sizing methodology and shows how the binding constraint changes based on property income, value, and market conditions.
The Three-Constraint Loan Sizing Method
CMBS lenders calculate the maximum loan under each constraint and use the lowest as the actual loan amount. LTV Constraint: Loan = Property Value × Max LTV. DSCR Constraint: Loan = NOI / (Min DSCR × Debt Constant), where the debt constant is the annual mortgage payment per dollar of loan. Debt Yield Constraint: Loan = NOI / Min Debt Yield. The binding constraint varies by interest rate environment: in low-rate environments, LTV typically binds; in high-rate environments, DSCR often binds because higher rates increase the debt constant.
Loan Sizing Worked Example
Property: 120-unit apartment, $20M value, $1.6M NOI. Loan terms: 6.0% rate, 30-year amortization. Lender requirements: 75% max LTV, 1.25 min DSCR, 9% min debt yield. LTV: $20M × 0.75 = $15.0M. Debt Yield: $1.6M / 0.09 = $17.78M. DSCR: Annual debt constant at 6%/30yr = 7.20%. Max annual debt service = $1.6M / 1.25 = $1.28M. Max loan = $1.28M / 0.0720 = $17.78M. Binding constraint: LTV at $15.0M. Actual DSCR at $15M: $1.6M / ($15M × 0.072) = $1.6M / $1.08M = 1.48. Actual debt yield: $1.6M / $15M = 10.67%.
Interest Rate Sensitivity on Loan Sizing
Interest rates affect DSCR-constrained loan sizing dramatically. Using the same property ($1.6M NOI), the DSCR-constrained maximum loan at 1.25x coverage changes with rates.
| Interest Rate | Debt Constant | DSCR-Max Loan | LTV-Max Loan | Binding Constraint |
|---|---|---|---|---|
| 4.0% | 5.73% | $22.3M | $15.0M | LTV |
| 5.0% | 6.44% | $19.9M | $15.0M | LTV |
| 6.0% | 7.20% | $17.8M | $15.0M | LTV |
| 7.0% | 7.98% | $16.0M | $15.0M | LTV or DSCR |
| 8.0% | 8.80% | $14.5M | $15.0M | DSCR |
Loan sizing sensitivity to interest rates ($20M property, $1.6M NOI, 1.25 DSCR, 75% LTV)
Go / No-Go Decision Framework
Go Indicators
- ✓CMBS loan size is the minimum of LTV, DSCR, and debt yield constraints.
- ✓In low-rate environments, LTV typically binds; in high-rate environments, DSCR often binds.
No-Go Indicators
- ✗Sizing the loan based on only one metric (typically LTV) without checking DSCR and debt yield: The loan amount may need to be reduced significantly when the lender applies the more restrictive DSCR or debt yield test
- ✗Using an assumed interest rate that differs from the rate environment at closing: A 50 bps rate increase between application and closing can reduce loan proceeds by 5-8%, creating a last-minute equity gap
Scenario: Determining the Binding Constraint on a CMBS Application
An investor is seeking CMBS financing on a $30M industrial property with $2.4M NOI. Lender requires: 70% LTV, 1.30 DSCR, 8.5% debt yield. Rate: 5.75%, 30-year amortization.
LTV is the binding constraint at $21M. DSCR and debt yield have significant headroom, indicating a strong credit profile.
Sources
Common Mistakes to Avoid
Sizing the loan based on only one metric (typically LTV) without checking DSCR and debt yield
Consequence: The loan amount may need to be reduced significantly when the lender applies the more restrictive DSCR or debt yield test
Correction: Calculate the maximum loan under all three constraints and use the smallest result as the actual maximum loan amount
Using an assumed interest rate that differs from the rate environment at closing
Consequence: A 50 bps rate increase between application and closing can reduce loan proceeds by 5-8%, creating a last-minute equity gap
Correction: Rate-lock early when possible, and model a 50-100 bps rate increase scenario to ensure the deal works even if rates move against you
Test Your Knowledge
1.What are the three primary constraints in CMBS loan sizing?
2.When interest rates rise, which CMBS sizing constraint typically becomes binding?
3.What is interest rate sensitivity analysis in loan sizing?