Debt yield
Debt yield is net operating income divided by the loan amount, expressed as a percentage. It measures the return a lender would earn on its loan if it took the property back and operated it, and unlike DSCR it is unaffected by interest rate, amortisation schedule or loan term.
How it works
Debt yield became a standard sizing test after the 2008 cycle, for a specific reason. In the years before it, falling interest rates and long interest-only periods let borrowers clear DSCR tests at leverage levels that had nothing to do with the property's actual income. A 1.25x coverage ratio can be achieved on almost any loan amount if the rate is low enough and the loan never amortises. Debt yield closes that door, because it contains no rate and no amortisation term at all.
That independence is the whole point. It answers one question: if this loan defaulted tomorrow, what unlevered yield would the lender be earning on its basis. A 10 percent debt yield means ten years of unlevered income at today's net operating income would repay the loan, which sets a floor under how much can be lent regardless of how attractive rates make the coverage math look.
Typical floors run 8 to 10 percent for stabilised multifamily and 9 to 12 percent for commercial property, higher for hotels and transitional assets, and they move with the rate environment and with credit conditions. In a low-rate market debt yield is usually the binding constraint. In a high-rate market DSCR normally takes over, because coverage tightens faster than the debt yield floor does.
Formula
Debt yield = net operating income / loan amount- Rearranged for sizing: maximum loan = NOI / debt yield floor
- Contains no interest rate, no amortisation term and no loan term, which is why it is stable across rate environments
- Lenders use their own underwritten NOI, normally with reserves deducted
Worked example
NOI $3,020,000, purchase price $55,900,000.
| Maximum loan at a 9.0% debt yield floor60.0% LTV | $33,555,556 |
|---|---|
| Maximum loan at an 8.25% floor65.5% LTV | $36,606,061 |
| Loan actually sizedthe 65% LTV cap bound first while the loan is interest only | $36,335,000 |
| Debt yield on the loan as sized | 8.31% |
Seventy-five basis points of movement in the floor changes proceeds by just over $3 million. On this deal, while the loan is interest only, the LTV cap happened to bind before the debt yield floor, but that ordering flips whenever cap rates compress. Once the loan amortises, coverage binds ahead of both.
Conventions worth knowing
- Debt yield and the going-in cap rate are related by leverage: debt yield equals the cap rate divided by the loan-to-value ratio. At a 5.4 cap and 65 percent LTV, the debt yield is 8.3 percent by construction.
- Because it excludes the rate, debt yield is the cleanest way to compare leverage across time. Loan-to-value moves with cap rates and DSCR moves with rates; debt yield moves with neither.
The common mistake
Computing it on your NOI instead of the lender's
A borrower calculating debt yield off a pro forma NOI, with the seller's tax basis and no replacement reserves, will land well above the number the lender computes on trailing performance with taxes reassessed and reserves deducted. The gap is routinely five to ten percent of NOI, which translates directly into loan proceeds. Size the deal on a conservative NOI and treat any additional proceeds as upside, because discovering the shortfall during the loan approval process means renegotiating the purchase price or writing a larger equity cheque.
Related terms
- Debt service coverage ratioThe debt service coverage ratio is net operating income divided by annual debt service. A 1.25x means the property produces $1.25 of income for every $1.00 of principal and interest owed, so net operating income could fall by 20 percent before coverage reaches 1.00x and the loan stops being covered.
- Loan to valueLoan to value is the loan amount divided by the property's value, expressed as a percentage. It is the most familiar leverage constraint and, on a purchase, is normally tested against the lesser of the appraised value and the purchase price.
- Loan sizingLoan sizing is the process of determining the maximum loan proceeds a property supports. A lender runs three independent tests, a loan-to-value cap, a minimum debt service coverage ratio at a stressed rate, and a minimum debt yield, and lends the lowest of the three.
- Cap rateA cap rate is a property's net operating income divided by its value or price, expressed as a percentage. It is the unlevered first-year yield on the purchase price and the standard shorthand for what a market is paying for a stream of property income.
- Net operating incomeNet operating income is a property's effective gross income less all operating expenses, before debt service, income taxes, depreciation and capital expenditure. It is the figure a cap rate is applied to, the numerator of debt yield and DSCR, and the number a purchase price is ultimately negotiated against.
Every figure, traced to its source
Altyst computes these in exact decimal arithmetic, not with a language model, and clicking any number shows the formula behind it.