Debt yield is a term, or ratio to be more precise, used in the commercial property market. The lenders are bidding farewell to the traditional debt service coverage ratio, while determining the loan amount, and increasingly using the debt yield formula. However, this is popularly used by the conduit lenders. Buzzle, in this article, talks about debt yield in the commercial property sector.
Yield refers to ‘return’ on any kind of investment, and any investor, before investing, would want to calculate the size of his returns. Similarly, ‘debt yield’ is a terminology commonly used in real estate, wherein the yield on debt is calculated by comparing the size of loan amount with the NOI (i.e. Net Operating Income) of the investor, i.e, should the investor default, how much can the lender foreclose2 the estate for.
It is one of the risk mitigation techniques used by lenders, especially, the conduit lenders3. Lower the yield, higher the risk. This formula does not consider the interest rates, cap ratio, etc., which traditional lenders use.
NOI of a commercial estate is the annual income generated (such as rent) by the commercial estate, after deducting operating expenses such as taxes, repairs and maintenance, utilities, etc.
The commercial estate market is usually volatile and ever-changing. Debt yield ratio breaks the traditional approach of lending market, and the underwriters try to measure the performance of their investment through the risk of default.