Debt yield is a metric used in commercial real estate and other finance areas to assess the risk associated with a loan. It measures how much a lender can expect to earn from a property in relation to the total amount of the loan. Here's how to calculate it:
Access the spreadsheet: https://docs.google.com/spreadsheets/d/1199TRfmGDQ2JSKp8m-kySMCFgjP4AZcWimdYMbpi8YU/edit?pli=1&gid=0#gid=0 (hit File and Make a Copy to edit it)
Steps to Calculate Debt Yield
Net Operating Income (NOI): This is the annual income generated by the property, typically calculated by subtracting operating expenses from the gross operating income.
Loan Amount: This is the total principal amount of the loan taken out on the property.
Calculation:
Divide the NOI by the loan amount to find the debt yield ratio.
If you are calculating this over time, you can target the beginning period loan balance against the NOI for the period. The debt yield will change each year as the principal is paid down and the NOI changes.
Normally, this metric is calculated annually.
Example
Suppose a property generates an NOI of $150,000 per year, and the loan amount is $2,000,000. The debt yield would be calculated as follows: $150,000 / $2,000,000.
This result means that the lender can expect to earn a 7.5% return on the loan amount annually from the property's operations. A higher debt yield indicates lower risk for the lender, as it suggests the property generates significant income relative to the loan amount.
Using a spreadsheet is highly effective for this type of analysis, allowing you to easily update assumptions and instantly see the impact on debt yield and other key metrics. If you need help setting up such a model, I can assist with that!
Why Commercial Property Lenders Care About Debt Yield?
Debt yield is a key metric that commercial real estate lenders use to assess the risk of a loan. It measures the annual income a property generates as a percentage of the loan amount. This helps lenders understand how easily a property's earnings can cover the loan payments.
A higher debt yield means lower risk for the lender, as it indicates the property is generating sufficient income relative to the size of the loan. This is crucial because if the borrower defaults, the lender wants to ensure they can still earn a reasonable return from the property’s income when compared to the loan amount.
Unlike other metrics like the loan-to-value ratio, which depends on fluctuating market values, debt yield is based solely on the property's current income. This makes it a more stable and reliable measure that isn't influenced by market conditions. Lenders also use debt yield to compare different investment opportunities and to enforce internal risk management policies and regulatory requirements.
Overall, debt yield is an essential tool for lenders in ensuring their loans are secure and profitable, providing a straightforward assessment of a property's financial health without being swayed by external market dynamics.
Article found in Real Estate.
