What Is a Good Debt Yield and How to Calculate It

A good debt yield is a crucial metric to understand when evaluating investment properties. A debt yield of 8-10% is generally considered good, according to industry standards.

The debt service coverage ratio (DSCR) plays a significant role in determining a good debt yield. A DSCR of 1.25 or higher is often seen as a benchmark for good debt yield performance.

Investors should aim for a debt yield that covers their mortgage payments, property taxes, and insurance. This ensures they can maintain a stable cash flow from their investment property.

A good debt yield is a crucial factor in determining the risk and safety of a loan. It's a metric used by lenders to estimate the time required to recoup their initial investment in the event of a default.

Most commercial real estate lenders aim for a debt yield range of 8% to 12%. If the debt yield is low, the implied risk to the lender is higher, as the property's operating cash flows may not meet the mandatory debt service.

Risk-averse investors tend to prefer debt yields above 12%, while opportunistic investors may be more open to distressed debt at 7%. However, the quality of the debt yield depends on the target risk and return profile carried by the lender.

A debt yield of at least 10% is considered good, as it indicates lower leverage and lower risk for the lender. Anything lower, and the lender may be unwilling to finance the property.

Here's a quick reference guide to debt yields:

Ultimately, the target yield is lender-specific and conditional on external factors, such as the current conditions of the credit markets.

Calculating debt yield is a straightforward process that involves a few simple steps. The debt yield is the ratio of a property's net operating income (NOI) to its total loan amount, expressed as a percentage.

The NOI is a fundamental real estate metric used to measure a property's cash flows and profitability. It's calculated by determining the property's total income and subtracting its operating expenses. The loan amount refers to the outstanding principal balance associated with real estate financing.

To calculate debt yield, you'll need to know the NOI and loan amount. The formula is: Debt Yield (%) = NOI / Loan Amount. For example, if a property has an NOI of $400k and a loan amount of $8 million, the debt yield would be 5%.

A higher debt yield is better for lenders as it means they're more likely to get paid back in full. Lenders prefer debt yields above 9% to limit their downside risk. If the debt yield is below 9%, the borrower may need to accept less leverage to get above that threshold.

Here's a step-by-step guide to calculating debt yield:

1. Calculate the NOI by determining the property's total income and subtracting its operating expenses.

2. Determine the loan amount, which is the outstanding principal balance associated with real estate financing.

3. Divide the NOI by the loan amount to get the debt yield percentage.

4. Multiply the result by 100 to express the debt yield as a percentage.

For instance, if a property has an NOI of $130,000 and an outstanding loan balance of $1,400,000, the debt yield would be 9.3%. A higher debt yield is better, as it indicates either a higher NOI or a smaller loan balance.

To illustrate this, let's consider a commercial property with an NOI of $1,000,000 and a loan of $10 million. The debt yield in this case would be 10%, as the NOI is 10% of the loan amount.

Here's a table summarizing the key points:

Keep in mind that a debt yield of 9% or higher is generally considered safe for lenders. If the debt yield is below 9%, the borrower may need to adjust the loan terms to get above that threshold.

Commercial real estate lending involves assessing the risk of a loan based on the property's income-generating potential. Lenders use various metrics to evaluate the risk of a loan, including debt yield.

Debt yield is a key metric in commercial real estate lending, calculated by dividing the annual income generated by a property by the total amount financed. This figure helps lenders determine how quickly a property can recoup its losses in case of borrower default.

A debt yield of 10-12 is generally considered strong, indicating less leverage and more income to support the loan amount. However, this can vary depending on the asset class, with riskier asset classes like retail and office requiring higher debt-yield ratios.

Lenders often use debt yield to "stress test" a loan and see if the cash flow would suffice to cover the debt service. A good debt yield can provide a buffer against potential losses, making it an essential consideration in commercial real estate lending.

Here's a comparison of debt yield requirements for different asset classes:

Keep in mind that these are general guidelines, and actual requirements may vary depending on the lender and specific loan terms.

A good debt yield is crucial for lenders to recoup their losses in case of borrower default. It's calculated by dividing the annual income generated by a property by the total amount financed.

Debt yield helps lenders assess the risk of a loan and ensure they're not over-leveraging themselves. This is because it shows how quickly a property can generate sufficient income to recoup an outstanding loan balance.

The debt yield can be skewed by extreme interest rates and amortizations, making it essential to consider other metrics like Debt Service Coverage Ratio (DSCR) and Loan to Value (LTV) ratio. A DSCR of 1.20x or higher is often considered a good indicator of a property's ability to repay debt obligations.

Lenders typically like to see an LTV ratio of 80% or less, as it indicates a lower risk of loan default. However, the cap rate, or capitalization rate, can also be a useful metric in evaluating equity investments and is calculated by dividing the NOI of a property by its market value.

The debt yield is a useful ratio to understand, and it's being utilized by lenders more frequently since the financial crash in 2008. By using debt yield, lenders can quickly get an objective measure of risk and compare loans with different structures.

Lenders consider several alternative metrics to evaluate the risk and return of a loan.

Debt Service Coverage Ratio (DSCR) measures the borrower's ability to repay annual debt obligations compared to the NOI the property generates.

The Loan to Value (LTV) ratio is calculated by dividing the loan amount by the value of the property.

Lenders typically like to see an LTV ratio of 80% or less.

Cap rate, or the capitalization rate, looks at NOI based on the value of the property.

The cap rate is calculated by dividing the NOI of a property by its market value.

The commercial real estate debt yield is similar to the yield on cost, which is a metric for developers to assess a project based on cost and returns.

Debt yield can be skewed by extreme interest rates and amortizations, which is why DSCR is used to measure the borrower's ability to repay debt.

In a choppy real estate environment, lenders want to be sure you can pay them back if the underlying property is distressed. They can figure this out quickly by comparing the debt yield to the market cap rate.

Ideally, the debt yield is significantly higher than the market cap rate. This is because lenders want to minimize their risk.

Since the cheap money era of the pandemic, the debt markets have changed dramatically. Loans are harder to get, and some lenders are "pencils down", meaning they no longer fund projects.

The debt yield is a great way to think like a lender when evaluating real estate projects that use leverage.