Cap Rate, DSCR and Debt Yield
A capitalization rate relates a property’s annual NOI to value. In a simplified direct-capitalization model, value equals NOI divided by the selected cap rate. The rate depends on market evidence and property risk; it is not the loan interest rate. A higher cap rate produces a lower indicated value for the same NOI.
Commercial DSCR compares defined underwritten income with debt service for the same period. Debt yield divides defined income, commonly NOI, by loan amount. Unlike DSCR, a simple debt-yield test does not change when the interest rate or amortization changes. Each measure looks at a different aspect of the transaction.
Lenders may apply value leverage, coverage and debt-yield constraints together. The smallest permitted amount can bind even when another ratio looks comfortable. Confirm whether the numerator is NOI or adjusted net cash flow and whether the qualifying debt payment is amortizing, interest-only or stressed. Do not assume the actual initial payment is always the qualification basis. Income uncertainty affects both value and loan sizing, so a modest rent or expense change can reduce proceeds through more than one channel. Present the calculations transparently rather than selecting only the metric that supports the largest requested loan.
Worked example
NOI is $90,000 and cap rate 6%, implying $1,500,000 value. A $1,000,000 loan has 9% debt yield. If annual debt service is $72,000, DSCR is 1.25. At a 7% cap rate, indicated value falls to about $1,285,714 even though NOI has not changed.
Mini glossary
- Cap rate
- NOI divided by value under stated assumptions.
- Debt yield
- Defined income divided by loan amount.
- DSCR
- Defined income divided by debt service for a consistent period.
Put it into practice
Calculate all three metrics using one annual income figure. Then increase the cap rate and debt payment separately. Explain which metrics change and why. Ask the lender which income definition, valuation evidence and qualifying payment it uses before converting these calculations into a proposed loan amount.
Recommended reading
Use these primary sources for context. Individual lender requirements can change; confirm the current program for your transaction.