Debt yield
Sector Deep DivesNet operating income divided by the loan amount, a sizing test that depends on neither the valuation nor the interest rate.
Also written: debt yield test
Debt yield is the simplest of the three property credit tests and the hardest to flatter. It divides net operating income by the loan, so it asks directly what return the building's income represents on the money advanced.
Its value is in what it excludes. Loan to value depends on a valuation, which is at its most generous at the top of a cycle, precisely when a lender should be most careful. Interest cover depends on the interest rate, which is at its most generous when money is cheap. Debt yield depends on neither, so it does not loosen just because the market has become optimistic.
That makes it a sizing tool rather than only a monitoring one. A lender with a 10% debt yield requirement will advance a fixed multiple of income whatever the appraisal says, which caps the loan in exactly the environment where the other two tests would allow more.
It began as a US commercial mortgage convention and has spread into European lending, particularly on secured loans against income producing assets. Its limitation is that it says nothing about the durability of the income: two portfolios on the same debt yield are not the same credit if one has most of its leases expiring within a year.
Worked example
A portfolio produces €50m of net operating income and carries €550m of debt, so the debt yield is about 9.1%.
A lender requiring 10% would advance €500m against that income, which happens to be a 50% loan to value at a €1,000m appraisal.
If the appraisal rose to €1,200m, loan to value would suggest room for €780m at 65%, and interest cover at a 3.0% coupon would allow far more still. Debt yield holds the loan at €500m regardless.