Debt yield is a measure of risk independent of interest rate and amortization, calculated by dividing a property’s net operating income by the total loan amount. Lower debt yields indicate higher leverage and more risk. Along with debt service coverage and loan to cost, debt originators use this metric for sizing mortgages.
Debt Service Coverage
Debt-Service Coverage Ratio (“DSCR”) is a measure of default risk. It is calculated by by dividing net operating income by debt service. Originators like to keep debt service coverage ratio greater than 125% and will award more favorable interest rates to properties with greater debt service coverage. However, some affordable housing loan programs allow for debt service coverage as low as 115%.
Break Even Ratio
Break Even Ratio measures the vulnerability of a real estate investment to default given a decrease in gross operating income. It is a proxy for the minimum occupancy required to meet debt obligations. In practice, the break even ratio is rarely used as it is not as accurate as a net operating income sensitivity study.