WHAT IS DEBT YIELD?
The debt yield ratio in commercial real estate is defined as Net Operating Income (NOI) divided by the proposed loan amount times 100. It does not use interest rates, amortization schedule, cap rates, LTV or other variables. It’s a stand alone metric that cannot be manipulated by changing terms of the loan to make the proposed loan amount more amicable. Debt yield is widely used by various lending sources and became common place after the real estate crash.
How to figure out Debt Yield for a proposed loan:
Figure out the Net Operating Income of the subject property. This is the underwritten cash flow of the property. In this example, we’ll use $500,000. Next, divide the Net Operating income by the proposed loan amount, $6,000,000 for example, and then multiply the result by 100.
($500,000) / ($6,000,000) = .0833 * 100 = 8.33% debt yield
So what does this mean for lenders? The lower the debt yield, the higher the perceived risk of the proposed loan. For this reason, lenders demand higher debt yields from riskier property types. This is why multifamily building loans typically have lower minimum debt yields than hotel loans.