Yield Maintenance 101 for CRE
The LoanBoss Team
September 06, 2022
The Basics
Yield maintenance for commercial real estate is a loan repayment method that allows a lender to receive all the interest payments agreed to, even when the borrower returns the entire loan amount early.
For instance, If you took out a 10-year, $10m, interest-only, fixed-rate loan on a property with an interest rate of 5%, you are responsible for $500k interest a year for ten years. That means that your lender expects to receive $5m in interest payments over the life of the loan.
But what happens if you decide to sell the property after five years? That depends on the prepayment provisions in your loan documents. Unlike residential mortgages, commercial loans come with a way of compensating the lender for the interest they lose when you pay your loan back early.
The Calculation
So your lender expects you to "maintain the yield" on your loan, even when you prepay it years in advance. To calculate the amount due, find the difference between the value of all future interest payments at the note rate and today's market rate. That difference is then present valued back to today and summed. That amount is the yield maintenance due when the loan is prepaid.
The Dangers
Just knowing that your prepayment provisions call for yield maintenance is not enough. The specific terms that govern your loan are critical. Incorrect or vague prepayment dates can impact property disposition plans. Humans drafted your loan documents, and humans aren't perfect. No matter how big the institution you are working with, it behooves borrowers to read carefully through prepayment terms and calculations. Know your lockout periods, open periods, and floors on interest rates, and confirm that maturity dates between Notes and Loan Agreements are synced.
Whether you use an automated platform to abstract, calculate, and manage your debt or not, understanding loan prepayment obligations and timing dispositions accordingly can significantly impact the profitability of your deals. Stay on top of them the same way you would lease agreements and property management contracts, or your debt can become the most important cost center you are not considering.