The exit test on a bridge loan, worked: debt yield, DSCR and LTV turned into required NOI, and the exit cap at which the refinancing fails.
A bridge loan refinances only if the stabilised NOI clears every test the takeout lender will apply at maturity, so the required NOI is the highest of three: balance times the debt yield minimum, balance times the loan constant times the DSCR minimum, and balance over the LTV limit times the exit cap rate. On an illustrative $36.0M balance, those are 3.06, 3.32 and 3.46. The loan-to-value test binds, the exit debt yield the plan really needs is 9.62 per cent, and a business plan at 3.80 has an 8.9 per cent cushion, not the 19.5 per cent that a debt yield test alone suggests.
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 →
A lender is asked to provide a three-year bridge on a partly let light industrial estate. In-place NOI is $1.20M; the sponsor's business plan, after leasing and capital works, reaches $3.80M. By maturity the loan will be fully drawn at $36.0M, including future funding for the works. The bridge lender is repaid only by a takeout loan, so the credit question is what that takeout lender will need to see. All figures and market levels are illustrative.
| Input | Value |
|---|---|
| Bridge balance at maturity | 36.0 |
| In-place NOI | 1.20 |
| Business plan stabilised NOI | 3.80 |
| Takeout debt yield minimum | 8.5% |
| Takeout DSCR minimum | 1.25x |
| Takeout rate, 30-year amortisation | 6.25% |
| Takeout maximum LTV | 65% |
| Exit cap rate used by the appraiser | 6.25% |
Turn each of the takeout lender's limits around: instead of asking what loan a given NOI supports, ask what NOI the existing balance requires.
Debt yield: NOI = 36.0 × 8.5% = 3.06
DSCR: loan constant at 6.25% over 30 years = 7.39%; NOI = 36.0 × 7.39% × 1.25 = 3.32
LTV: value needed = 36.0 / 65% = 55.38; NOI = 55.38 × 6.25% = 3.46
Required NOI = MAX(3.06, 3.32, 3.46) = 3.46, an exit debt yield of 9.62%
Excel: =MAX(Bal*DY, Bal*(-PMT(r/12, 30*12, 1)*12)*DSCR, Bal/LTV*ExitCap)
The binding test is the one that requires the most NOI, here the LTV test. Expressed as an exit debt yield, the bridge needs 9.62 per cent on its balance, against the 8.5 per cent the takeout lender quotes as its debt yield floor. The business plan delivers 10.56 per cent, so the cushion is 0.34 of NOI, or 8.9 per cent of the plan.
| Test | Required NOI | As a debt yield | Cushion vs plan |
|---|---|---|---|
| Debt yield 8.5% | 3.06 | 8.50% | 19.5% |
| DSCR 1.25x | 3.32 | 9.24% | 12.5% |
| LTV 65% | 3.46 | 9.62% | 8.9% |
Seen from the in-place position, the business must grow NOI by 188 per cent just to refinance; the plan assumes 217. The bridge lender relies on the first 188 points of that growth being delivered; the last 29 points are its only cushion.
The two market inputs at maturity are the cap rate the appraiser uses and the rate the takeout lender charges. Neither is known at origination, so the exit test is run as a grid.
| Exit cap rate | Takeout at 5.50% | at 6.25% | at 7.00% |
|---|---|---|---|
| 5.75% | 3.18 (LTV) | 3.32 (DSCR) | 3.59 (DSCR) |
| 6.25% | 3.46 (LTV) | 3.46 (LTV) | 3.59 (DSCR) |
| 6.75% | 3.74 (LTV) | 3.74 (LTV) | 3.74 (LTV) |
| 7.25% | 4.02 (LTV) | 4.02 (LTV) | 4.02 (LTV) |
At a 6.75 per cent exit cap the plan's 3.80 still clears, by 1.6 per cent. At 7.25 per cent it fails: the takeout lender would advance only $34.07M on the plan NOI, leaving a gap of $1.93M that the sponsor must fund or the bridge lender must extend. The plan NOI fails the LTV test at any exit cap above 6.86 per cent, only 61 basis points wider than the base assumption.
The debt yield test never binds in this grid. It is the test that does not depend on rates or cap rates, which is why lenders like it at origination. At maturity that same independence makes it the least informative of the three: it tells the bridge lender nothing about the two market variables most likely to move against it.
The common shortcut is to underwrite the exit on debt yield alone: required NOI of 3.06, a 19.5 per cent cushion, a comfortable credit. It is the easiest test to compute and the one most often quoted in term sheets. On these inputs it overstates the cushion by more than two times, because both the coverage test and the value test need more NOI than the debt yield floor.
The second mistake is running the exit test on the balance at closing rather than at maturity. Future funding for capital works and leasing costs, and any interest reserve funded from the loan, all add to the balance the takeout must repay. A test on the day-one balance of a bridge with heavy future funding can understate the required NOI by a tenth or more.
The sizing and exit-test model in the free workbook for this case runs the test on debt yield alone and on every test you set, for a good and a bad case. To size the loan at origination with the same four tests, the loan sizing template names the binding one, and margin says one thing, return on capital says another prices what the lender is paid for the risk.
It is the stabilised NOI the business plan must reach, divided by the bridge balance at maturity, that lets a takeout lender repay the bridge. It should reflect every takeout test, not only the debt yield floor. In the worked case the floor is 8.5 per cent but the LTV test raises the exit debt yield required to 9.62 per cent.
It depends on rates and cap rates at maturity. In the example, at a 5.75 per cent exit cap and a 6.25 per cent takeout rate the DSCR test binds at 3.32 of NOI; at a 6.25 per cent cap or wider the LTV test binds. The debt yield test, independent of both, did not bind anywhere in the grid.
Compare the business plan NOI with the NOI the binding takeout test requires on the balance at maturity, and find the exit cap at which the two meet. With plan NOI of 3.80 against 3.46 required, the cushion is 8.9 per cent, and the plan fails the LTV test at any exit cap above 6.86 per cent.
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.
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