Can Debt Yield Covenants Help Finance Green Real Estate?

 

Can the debt market’s use of debt yield covenants help green real estate investors qualify for greater loan proceeds?

In my upcoming article, “Present Your Green Property to Lenders“, I explain how you can structure your commercial real estate loan applications in a way that helps lenders to evaluate the value that green features bring to their sustainable commercial property.

Naturally, investors also want to ensure that all the other ‘usual’ parts of your loan application package answer your lender’s typical credit concerns, as well — particularly how lenders are handling the current problem of unreliable property valuations.

Today’s post on The Ground Floor highlights the “emergence” of the debt yield as a lender’s preferred measure of the NOI cushion available to pay debt service. Their quote:

In fact, debt yield, which measures net operating income as a percentage of the loan amount, is emerging as the main tool because it is viewed as the most direct method for calculating risk. The higher the debt yield, the more attractive the mortgage is to the lender. When the market was hot and properties were trading actively, the loan-to-value ratio was the go-to benchmark for lenders, and negotiations with borrowers typically hinged on the degree of leverage that would be employed. But now, the sales-market freeze is making it hard to pinpoint how far property values have fallen. What’s more, there’s no sign that property values have hit bottom yet. Against that backdrop, lenders are turning to the debt yield.

I chuckled about the use of the term “emerging”.  In my prior life as a portfolio lender through several economic cycles, debt yield covenants have always been around and most of the loans that I funded contained a two-pronged loan-to-value and debt yield test.  In the heady days of the market boom, many lenders simply manipulated their debt yield calculations to win business or just dropped them altogether in favor of more lenient loan-to-values. So I wouldn’t describe the current trend as “emerging”. It’s always been around.

In any event, we can confirm the current trend of lenders applying a strong debt yield based upon trending existing rents forward (no increases of current rental rates allowed) as an essential part of any successfully funded debt deal these days.  And there is nothing about a property’s sustainability that will exclude it from this evaluation.

But think about this –> one of the longstanding problems that investors face with financing green properties is that of getting appraisers to recognize economic value contributed by green design and specific property features.  In a way, this has left some investors grumbling that the appraisal process can actually be more detrimental for the green property than the brown. However, in this particular lending environment of focusing on NOI over valuation  via using debt yield tests, green property developers and investors who can prove how their sustainability strategies improve their asset’s NOI should have an easier time working with the lender on the desired loan amount.