What is a Debt Yield?

The debt yield ratio, often simply referred to as debt yield, is a highly used metric in commercial real estate finance that measures the profitability of an investment. Lenders typically regard the debt yield to be highly important, as they typically utilize it as one of the factors for determining the risk of loaning money. More precisely, lenders analyze debt yield in order to determine how long it would take to recoup their investment should the borrower default on the loan, and they must seize the property. 

Unlike other common risk mitigation metrics like the loan to value (LTV) ratio and debt service coverage ratio (DSCR), debt yield is highly favored in commercial finance for being unaffected by common factors that typically prevent an accurate determination of risk. Variables such as market valuation, amortization periods, and interest rates have been known to create inaccuracies in LTV and DSCR calculations. Because of this, many commercial real estate lenders set a minimum debt yield requirement in an effort to mitigate risk.

Debt Yield Calculator

Debt Yield Calculation

The formula for determining the debt yield of a property is as follows:

Debt Yield Ratio = Net Operating Income / Total Loan Amount

To calculate an asset’s debt yield, the property’s net operating income (NOI) must be divided by the total loan amount used to acquire the property. To get a clearer understanding of the calculation, imagine a commercial property with a net operating income of $600,000 that was acquired with a $2,500,000 loan. The debt yield for this asset would be $600,000 divided by $2,500,000 which equals 0.240 or 24%.

In an effort to mitigate risk, many lenders and loan programs have debt yield minimums that must be adhered to. Interestingly, borrowers can use this to their benefit since it’s technically possible to calculate a potential maximum loan amount so long as the net operating income of the property is known. For example, if a loan has a minimum debt yield requirement of 15%, all an investor would have to do is take the NOI of the target asset and divide it by the given debt yield requirement. Looking at the earlier example above, a borrower would be eligible for a maximum loan sum of $4 million (providing that amount was consistent with other factors, like LTV and DSCR).

$600,000/0.15 = $4,000,000

What is a Good Debt Yield?

As with most commercial real estate metrics, whether or not a debt yield can be considered “good” largely depends on a variety of factors. Variables such as the property type, the state of the market and current economy, the financial strength of tenants, can have large impacts on how a debt yield is valued. Still, the widely utilized industry standard for minimum acceptable debt yield is 10% — which technically makes any debt yield value greater than 10% a “good” debt yield.