Why Debt Yields Matter in Commercial Real Estate
When evaluating commercial real estate (CRE) investments, most people focus on metrics like cap rates, loan-to-value ratios (LTV), or debt service coverage ratios (DSCR). While those are important, there’s another metric lenders (and savvy investors) watch closely: debt yield.
What is Debt Yield?
Debt yield is the lender’s return on a loan if they were to take over the property today. It’s calculated as:
Debt Yield = Net Operating Income (NOI) ÷ Loan Amount
Unlike DSCR or LTV, debt yield strips away variables like interest rates or amortization schedules. It’s a pure measure of how much income a property generates relative to the debt.
Why Lenders Rely on It
Debt yield gives lenders a quick way to assess risk:
Protection against inflated values: LTV ratios can be distorted by market swings or overly optimistic appraisals. Debt yield keeps the focus on actual income.
Consistency across loan types: Whether fixed-rate, floating, short-term, or long-term, the debt yield calculation stays constant.
Stress testing: If a property underperforms, debt yield indicates how much cushion exists before the lender takes on too much risk.
For example, most lenders want a minimum debt yield of 8–10%. That means for every $1 million loan, the property should generate at least $80,000–$100,000 in annual NOI.
Why It Matters for Investors
If you’re underwriting a deal, paying attention to debt yield can save you headaches:
Stronger financing terms: Properties with healthy debt yields are more attractive to lenders, leading to better rates and flexibility.
Deal comparison tool: You can quickly compare risk across multiple assets without being skewed by interest rate environments.
Future-proofing: As interest rates change, debt yield remains a stable metric that tells you whether a deal stands on its own merits.
The Bottom Line
In CRE, debt yield isn’t just a lender’s metricit’s an investor’s safeguard. By running the numbers yourself, you can better understand the true resilience of your investment, especially in a market where financing is tightening.
