Cap Rate Analysis
Debt Yield, DSCR, and Why Conservative Leverage Wins Real Estate Cycles
Loan-to-value gets the headlines. Debt yield and debt service coverage are what actually keep a real estate portfolio alive through a downturn. A primer for owners thinking about how to finance or refinance a commercial asset.
Three Ways Lenders Size a Loan
Commercial real estate lenders constrain loan size three ways: loan-to-value (LTV), debt service coverage ratio (DSCR), and debt yield. Whichever ratio binds first dictates the loan amount, and in today's market DSCR and debt yield bind long before LTV does.
LTV is a function of appraised value, which is a function of cap rate, which moves with interest rates. DSCR and debt yield are functions of NOI and the actual debt cost. They are closer to physical reality and harder to game.
What Debt Yield Really Tells You
Debt yield equals NOI divided by Loan Amount. A $10M loan against $900K of NOI is a 9.0% debt yield. Lenders want debt yield at or above 8 to 10% on stabilized assets. Agency multifamily lenders may accept lower, while bridge and value-add lenders want higher.
Debt yield is independent of cap rate and interest rate, which is exactly why lenders use it. It measures the unlevered return on the loan amount: what a lender would earn if they took the property back.
DSCR: Can the Property Service the Debt?
DSCR equals NOI divided by Annual Debt Service. A 1.25x DSCR means NOI is 25% above debt service. Conservative borrowers underwrite to 1.30 to 1.40x on permanent debt. Tighter coverage leaves no room for short-term NOI dips.
DSCR is sensitive to interest rates. A loan that supported 1.30x DSCR at a 5% coupon may only support 1.05x at 7%. That is why refinances are stressful in a rising-rate environment even when property fundamentals are intact.
The Case for Conservative Leverage
Aggressive leverage amplifies returns when assumptions play out. It also amplifies the consequences when they do not. The owners who lost portfolios in 2008, in 2020, and in the 2022 to 2024 rate cycle had one thing in common: they were levered to the point where any deviation from the plan forced them to sell or recapitalize at the worst possible time.
Conservative leverage (typically 55 to 65% LTV, comfortably above 1.30x DSCR, debt yield above 9%) does not maximize return in good years. It does maximize survival in bad ones, and surviving is the prerequisite for compounding.
How We Capitalize Our Acquisitions
Price Capital Group sizes debt to the metrics above, not to the maximum a lender will offer. We use fixed-rate debt where the hold period supports it, and we maintain reserves above lender minimums so a quarter of soft NOI does not trigger a covenant breach.
If you are an owner thinking about a sale, recapitalization, or joint venture on a South Florida commercial property, we will walk you through how we would capitalize the asset and what that means for the offer.
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