Debt Yield

The formula is simple: NOI divided by loan amount, as a percentage. What it actually measures is the lender's unlevered cash-on-cash return on the loan balance in the scenario the lender hopes never to face, foreclosing and taking the keys. A 10.5 percent debt yield means the lender would earn a 10.5 percent return on its own money, at the current NOI, if it owned the asset outright at the loan amount.

Debt yield is rate-independent, which is what separates it from DSCR and makes it useful to a lender in a way the other two tests are not. DSCR moves with the interest rate and the amortization schedule; loan-to-value moves with the appraisal, which federal banking rules generally require on commercial real estate loans above $500,000.^[1] Debt yield moves only when NOI or the loan amount changes, which means it cannot be flattered by a longer amortization schedule, an optimistic appraisal, or a temporarily low rate.

That immunity is exactly why CMBS lenders lean on debt yield as a primary sizing test. A CMBS loan is pooled and sold to bond investors who are not in the room during underwriting, and a test that cannot be gamed through amortization stretching or appraisal shopping gives those investors a cleaner floor on loan quality. We have not found a lender program that publishes its hotel debt yield floor, so ask for the test in writing. CMBS sizing is disclosed deal by deal in offering documents filed with the SEC, after the loan is written.^[2]

Debt yield and cap rate are related but not the same calculation, and confusing them is the most common error. Cap rate divides NOI by purchase price; debt yield divides the identical NOI by the loan amount instead. Because the loan amount is smaller than the purchase price whenever there is equity in the deal, debt yield is always a higher percentage than the cap rate on the same asset. The two numbers would only converge if the loan equaled the full price, which no lender offers.

To find which of the three sizing tests, debt yield, DSCR, or loan-to-value, actually binds on a specific deal, run all three and take the smallest resulting loan amount. The worked example below shows this directly: an appraisal change moves the LTV test and can shift which test binds, while the debt yield number does not move at all, because it never touched the appraisal in the first place.