Difference between Debt Service Coverage Ratio and Debt Yield
I think there's some nuance I'm missing here, could someone help break it down for me?
Debt yield: net operating income/total loan amount
Debt service coverage ratio: net operating income/total debt service
Thanks!
Whats the question? One is expressed as % above debt service (ie 1.25X is 25% above total debt service) the other is simply NOI or adjusted NOI / loan amount. The only nuance I can think of is that in my view yield should be tracked on current loan amount not simply initial principal.
Debt service coverage ratio is the NOI/debt service IN A GIVEN YEAR Debt yield is NOI/loan amt
Can think of the DY as the unlevered CoC for the lender or the debt holders cap rate.
DSCR can think of as how many times over can the lender pay its debt.
sorry why should it be thought of as the unlevered CoC?
Could be wrong here - but it's analogous to how cap rates are a proxy for unlevered returns. If you assume NOI is steady state and ignore the impact of below the line items, downtime, structural vacancy etc. then your cap rate = your unlevered returns. Now your CoC return is equal to your unlevered returns if you assume entry cap = exit cap and entry NOI = exit NOI
Now extend the same idea to a DY since it's effectively the lender version of a cap rate
They're usually more or less equivalent in a term sheet if that's what you're asking. DY should be close to DSCR x constant.
Yes - is helpful to know the relationship between mortgage constant, debt service coverage ratio, and debt yield and converting them.
Say a lender uses 7%/30-yr for calculating debt service in their underwriting or term sheet. That is equivalent to a 7.98% mortgage constant (=PMT(7%/12,30*12,-1)*12)
Also can be used for figuring out max loan amount based on a given NOI. Say NOI is $5MM and lender is using a 7.98% constant.
Both DY and DSCR are useful and should be taken into account. Debt yield is useful because it's apples to apples, whereas DSCR depends on the mortgage constant being used, which varies from lender to lender. If a mortgage broker tells me they have a deal with a 1.25x DSCR, that's not very helpful because we're probably using different interest rates. However DY doesn't take into interest rates, which is obviously important these days. Two years ago when rates were low, a 7% DY looked solid and produced a fine DSCR. But with rates higher today, that same 7% DY is 1.00x.
Two dumb questions here, but I've always wondered... what does the loan constant actually tell you, and why do you care about it?
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