Debt Yield

The ratio of Net Operating Income (NOI) to the mortgage loan amount, expressed as a percentage. The debt yield is useful to lenders as it represents the lender’s return on cost were it to take ownership of the property. Among other metrics, lenders use debt yield to determine an appropriate loan amount.

Putting ‘Debt Yield’ in Context

Red River Industrial Properties, a private equity firm focused on industrial assets, is in the process of acquiring the Sooner Logistics Center, a 250,000 square foot warehouse and distribution facility located in Oklahoma City, OK. The property is strategically positioned near major highways and serves several regional e-commerce tenants. Red River Industrial Properties is pursuing this asset as a core-plus acquisition, as the property is already stabilized with consistent cash flow but has opportunities for operational improvements to enhance value.

Key Property and Loan Details:

• Net Operating Income (NOI): $1,540,000 annually
• Purchase Price: $28,000,000
• Proposed Loan Amount: $18,000,000
• Interest Rate on Loan: 5.25%
• Amortization Period: 30 years

Debt Yield Calculation:

The debt yield is a critical metric used by lenders to assess the risk of a loan. It indicates the return a lender would receive from the property’s NOI if they had to take ownership in the event of a default. A higher debt yield suggests a lower risk, as the property’s income is sufficient to cover the loan.

Debt Yield is calculated using the following formula:

Debt Yield = (NOI / Loan Amount) × 100

Using the provided NOI for the Sooner Logistics Center:

Debt Yield = ($1,540,000 / $18,000,000) × 100 = 8.56%

Lender’s Perspective:

With a debt yield of 8.56%, the lender views this loan as approaching the lower end of the acceptable risk spectrum for industrial assets. Debt yields in the industrial sector typically range from 8% to 12%, depending on market conditions and property specifics. A debt yield of 8.56% indicates that the NOI covers the loan but offers a more modest margin of safety if the lender had to take over the property.

This debt yield is within the acceptable range but may prompt the lender to conduct additional due diligence on other risk metrics, such as the loan-to-value (LTV) ratio and the debt service coverage ratio (DSCR).

• Loan-to-Value (LTV) Ratio:
  LTV = ($18,000,000 / $28,000,000) × 100 ≈ 64%
  This ratio is comfortably within the typical range for core-plus industrial assets, which generally accommodate LTV ratios between 65% and 75%.
• Debt Service Coverage Ratio (DSCR):
  Annual Debt Service Calculation:
  The annual debt service for a $18,000,000 loan at 5.25% interest over 30 years is approximately $1,194,480. This is calculated using the standard mortgage payment formula:

  Monthly Payment = P × [c(1 + c)ⁿ] / [(1 + c)ⁿ – 1]

  Where:
  P = $18,000,000
  c = 5.25% / 12 = 0.4375%
  n = 30 × 12 = 360 months

  Monthly Payment ≈ $99,540 (total annual debt service ≈ $1,194,480)

  DSCR = NOI / Annual Debt Service = $1,540,000 / $1,194,480 ≈ 1.29x
  The DSCR of approximately 1.29x means the property’s cash flow exceeds the debt service by 29%. While this is above the lender’s typical minimum requirement of 1.20x, the lender may still seek assurances about future NOI growth potential to mitigate the lower margin of safety compared to higher DSCR values.

Conclusion:

In this scenario, Red River Industrial Properties and its lender utilize the debt yield as a key metric to evaluate the loan’s risk. With a debt yield of 8.56%, the lender perceives this loan as moderate risk, necessitating the borrower to ensure stable NOI growth in the future. For Red River, this debt yield calculation is crucial for securing financing under reasonable terms and effectively managing their core-plus acquisition strategy.

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