Three sizing tests, three loan amounts, and the one that binds depends on the interest rate more than on the property.
The maximum loan on a commercial property is the lowest of three amounts: value times the maximum LTV, NOI divided by the minimum DSCR and by the mortgage constant, and NOI divided by the minimum debt yield. On an illustrative property with $3.6 million of NOI, the DSCR test allows $37.97 million, below $39.0 million on LTV and $40.0 million on debt yield, so the DSCR binds. Drop the rate by a point and LTV binds instead.
Worked in full in The Real Estate Debt Investor by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
This is sizing at origination: the question is how much the lender will advance on day one. Testing how far income can fall after closing before one of the same ratios breaches is a separate, monitoring exercise. The case is a stabilised, single-asset senior loan request. The lender's three limits are typical of a conservative balance-sheet lender; all figures are illustrative.
| Input | Value |
|---|---|
| Underwritten NOI | $3.60m |
| Valuation cap rate | 6.0% |
| Appraised value (NOI / cap rate) | $60.0m |
| Interest rate, fixed | 6.5% |
| Amortisation, years, monthly payments | 30 |
| Maximum LTV | 65% |
| Minimum DSCR | 1.25x |
| Minimum debt yield | 9.0% |
LTV test: $60.0m x 65% = $39.00m
Debt yield test: $3.60m / 9.0% = $40.00m
DSCR test: maximum annual debt service = $3.60m / 1.25 = $2.88m
Mortgage constant at 6.5% over 30 years, monthly = 12 x PMT(6.5%/12, 360, -1) = 7.58%
Loan = $2.88m / 7.58% = $37.97m
Maximum loan = MIN(39.00, 40.00, 37.97) = $37.97m
In Excel, with NOI in B2, value B3, rate B4, years B5, LTV B6, DSCR B7 and debt yield B8: =MIN(B3*B6, B2/B8, PV(B4/12,B5*12,-B2/B7/12))
The PV form of the DSCR test avoids computing the constant separately: it asks what loan a monthly payment of one twelfth of $2.88 million amortises over 360 months. At the binding amount the loan runs at 63.3 per cent LTV, a 9.5 per cent debt yield and exactly 1.25 times cover.
| Test | Loan allowed | Headroom over binding |
|---|---|---|
| LTV at 65% | $39.00m | $1.03m |
| Debt yield at 9.0% | $40.00m | $2.03m |
| DSCR at 1.25x, 6.5%, 30 years | $37.97m | binds |
The LTV and debt yield tests do not depend on the interest rate; the DSCR test does, through the mortgage constant. That makes the rate the switch that decides which test binds.
| Rate | Constant | LTV loan | DSCR loan | Debt yield loan | Binds | Maximum loan | LTV at maximum |
|---|---|---|---|---|---|---|---|
| 5.5% | 6.81% | 39.00 | 42.27 | 40.00 | LTV | 39.00 | 65.0% |
| 6.5% | 7.58% | 39.00 | 37.97 | 40.00 | DSCR | 37.97 | 63.3% |
| 7.5% | 8.39% | 39.00 | 34.32 | 40.00 | DSCR | 34.32 | 57.2% |
The switch point is the rate at which the constant equals the maximum debt service divided by the LTV loan, $2.88m / $39.0m = 7.38 per cent, which is a rate of 6.24 per cent. Below it, valuation limits the loan; above it, income does. A one-point rise from 6.5 to 7.5 per cent removes $3.65 million of proceeds without any change in the property.
The debt yield test never binds here, because the cap rate of 6.0 per cent sits above the threshold at which it would: 9.0 per cent times 65 per cent, or 5.85 per cent. At tighter cap rates the value supports more debt than the income, and the debt yield, not LTV, sets the ceiling; only the DSCR test can then cut the loan further.
Interest-only does not always help. At 6.5 per cent interest-only, the DSCR loan rises to $44.31 million, but LTV still caps the loan at $39.00 million. The borrower gains $1.03 million, not the $6.3 million the DSCR test alone suggests.
Amortisation is the borrower's second lever on the DSCR test, and it is usually cheaper to negotiate than the rate. A longer schedule lowers the constant and raises the DSCR loan, until another test takes over.
| Amortisation, years | Constant | DSCR loan | Maximum loan |
|---|---|---|---|
| 25 | 8.10% | 35.54 | 35.54 |
| 30 | 7.58% | 37.97 | 37.97 |
| 35 | 7.25% | 39.72 | 39.00 |
Moving from 25 to 30 years adds $2.43 million of proceeds. Moving to 35 years adds only $1.03 million more, because LTV binds at $39.00 million before the DSCR loan of $39.72 million can be used. A borrower who fights for a longer schedule than the one that brings DSCR level with LTV is negotiating for nothing.
The frequent error is sizing on the wrong NOI. Lenders size on their own underwritten NOI, with market vacancy, a management fee and capital reserves deducted, while the appraisal may capitalise a higher figure. If the lender underwrites $3.24 million, 10.0 per cent below the $3.60 million used above, and the appraised value stays at $60.0 million, the DSCR loan falls to $34.17 million, a 57.0 per cent LTV. A borrower who quoted 65 per cent leverage to its own investors on the strength of the valuation finds the gap only at the term sheet.
The second error is computing the DSCR loan with the interest rate instead of the mortgage constant on an amortising loan. Dividing $2.88 million by 6.5 per cent gives $44.31 million, the interest-only figure, and overstates proceeds by 16.7 per cent.
Run all three tests, take the minimum and name the binding one: $37.97 million on DSCR here, with LTV $1.03 million behind it. Then check the switch rate, because the binding test will change before the loan closes if rates move. The loan sizing template runs the same three tests, the blank sizing and exit-test model is in the free workbooks for this book, and which covenant breaches first picks up after closing, measuring the income fall each ratio can absorb before it breaches.
The mortgage constant is annual debt service, interest plus amortisation, per dollar of loan. At 6.5 per cent with 30-year monthly amortisation it is 7.58 per cent. The DSCR loan is NOI divided by the minimum DSCR and then by the constant: $3.6 million / 1.25 / 7.58 per cent gives $37.97 million.
When the cap rate is below the minimum debt yield times the maximum LTV. With a 9.0 per cent debt yield and 65 per cent LTV that threshold is 5.85 per cent. Below it, the valuation supports more debt than the income does, and the debt yield, not LTV, sets the ceiling; only the DSCR test can cut the loan further.
Only if the DSCR test is the one that binds. Interest-only at 6.5 per cent lifts the DSCR loan on $3.6 million of NOI from $37.97 million to $44.31 million, but the 65 per cent LTV still caps the loan at $39.0 million, so the borrower gains $1.03 million, not $6.3 million.
This article is one calculation from The Real Estate Debt Investor. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
Get the book on Amazon →Free companion files
Also on Amazon UK · Amazon Germany · Amazon France · Amazon Canada
Reading guide: real estate investing, finance and fund management → · All 453 articles →
If this book helped, or didn’t, a few lines on Amazon are worth more than they look: they are what the next reader goes on. Write a review. The workbook stays free either way.