The short answer
Lenders size loans against three tests — debt service coverage, debt yield, and loan-to-value — and take the lowest of the three answers. Which test binds tells you what to work on: coverage problems are fixed by structure, debt yield problems by NOI, and value problems by the appraisal or by more equity.
Sponsors routinely go to market expecting a loan amount, and come back with less. Almost always the reason is that they sized against one constraint and the lender sized against three, taking the most restrictive.
Understanding the three tests, and diagnosing which one binds on your deal, is the single most useful piece of pre-marketing work you can do. It tells you whether your proceeds expectation is realistic, and if it is not, which lever will actually move it.
Test one: debt service coverage ratio
DSCR is net operating income divided by annual debt service. A lender requiring 1.25x coverage is saying that NOI must exceed the debt payment by 25%, giving a cushion for underperformance before the loan cannot pay itself.
The important thing about DSCR is that it is sensitive to loan terms, not just to the property. The same NOI supports very different loan amounts depending on the interest rate, the amortisation period, and whether the loan is interest-only. A thirty-year amortisation produces a lower annual payment than a twenty-five-year one, which supports more principal at the same coverage. An interest-only period supports more still.
That is why DSCR-constrained deals are structural problems with structural solutions. If coverage is binding, the productive conversation is about amortisation, interest-only periods, and rate — not about the property.
Two details that catch sponsors out. First, lenders underwrite their own NOI, not yours: they apply market vacancy rather than actual if actual is unusually low, add a management fee whether or not you pay one, deduct a replacement reserve per unit or per square foot, and normalise expenses to their own view. Second, on a floating-rate loan many lenders test coverage against a stressed rate or an interest-rate floor rather than the current rate.
Test two: debt yield
Debt yield is net operating income divided by the loan amount. A lender requiring a 10% debt yield will lend no more than ten times NOI, whatever the coverage maths or the appraised value says.
Debt yield exists because both of the other tests can be gamed by market conditions. Low interest rates flatter DSCR. Low cap rates flatter LTV. Debt yield references nothing but the property's own income against the loan, which is why it became a standard constraint after the last cycle in which both other tests proved unreliable.
It also answers a specific lender question: if I foreclosed tomorrow, what unlevered return would I be earning on my loan basis? That framing is why debt yield is the hardest of the three tests to negotiate. It is not a modelling assumption; it is the lender's floor on their own recovery economics.
If debt yield binds, the only real fix is more NOI. Not better loan terms, not a higher appraisal. That is worth knowing before you spend six weeks negotiating structure that cannot help.
Test three: loan-to-value
LTV is the loan amount divided by appraised value, or on an acquisition, the lower of appraised value and purchase price. It is the most familiar test and, in the current environment, often not the binding one.
The critical point about LTV is that the value in the denominator is the appraiser's, not yours and not the seller's. Sponsors who size against their own view of value and receive an appraisal that disagrees discover the gap late, when it is expensive to fix. On a value-add or development deal, understand precisely which value the lender is using — as-is, as-stabilised, or as-completed — because they can differ substantially and the loan-to-cost test may bind independently.
The lowest number wins
Run all three tests and the lender lends the smallest result. That is the entire sizing exercise, and it is why a single-constraint estimate is so often wrong.
| If this binds | It means | What actually helps |
|---|---|---|
| DSCR | The payment is too large relative to income at the required cushion | Longer amortisation, interest-only period, lower rate, rate buy-down |
| Debt yield | The loan is too large relative to income, regardless of terms | More NOI — nothing else moves it |
| LTV or LTC | The loan is too large relative to appraised value or total cost | More equity, a lower basis, or a defensible higher valuation |
Do this before you go to market
Build your own three-constraint model using conservative lender assumptions rather than your own. Apply market vacancy. Include a management fee. Include a replacement reserve. Normalise anything unusual in the expense history. Then test coverage at a stressed rate, not today's rate.
The result is a proceeds range you can defend, and — more valuably — a clear view of which constraint binds. That single piece of knowledge changes how you approach the market. A DSCR-constrained deal should be shopped to lenders who offer longer amortisation and interest-only flexibility. A debt-yield-constrained deal needs either a lender with a lower debt yield floor or a plan to demonstrate higher sustainable NOI. An LTV-constrained deal needs equity, a subordinate tranche, or a better basis.
None of that is knowable if you have only run one test.
Where the gap goes
When the binding constraint produces less senior debt than your capital plan needs, the shortfall is the subordinate requirement. That is the point at which mezzanine debt, preferred equity, or additional common equity enters the conversation — and it is much better entered with an accurate number than an optimistic one.
Frequently asked questions
What is a good DSCR?
It depends on the asset, the lender, and the loan structure rather than there being a universal number. Stabilised multifamily with agency execution is typically underwritten to lower coverage requirements than transitional assets or specialty property types. Rather than target a number, ask each lender what coverage they require, on what NOI definition, and at what assumed rate — those three inputs move the answer more than the ratio itself.
Why do lenders use debt yield when they already have DSCR and LTV?
Because both of the others can be flattered by market conditions — low rates inflate DSCR capacity and low cap rates inflate appraised value. Debt yield compares the property's income directly to the loan amount with no rate or valuation assumption in between, which tells the lender what unlevered return they would earn on their basis if they took the property back.
Which constraint is easiest to improve?
DSCR, because it responds to loan structure — longer amortisation, an interest-only period, or a lower rate all increase the supportable loan at the same coverage. Debt yield is the hardest, since only higher NOI moves it. LTV sits in between, requiring either more equity, a lower basis, or a defensible higher valuation.
Will a lender use my NOI figure?
No. Lenders underwrite their own NOI, typically applying market vacancy rather than actual, adding a management fee whether or not you pay one, deducting a replacement reserve, and normalising unusual expense items. Building your model on lender assumptions rather than your own is the fastest way to make your proceeds expectation accurate.
This article is general information about capital structures and financing mechanics. It is not investment, tax, accounting, or legal advice, and it is not an offer to sell or a solicitation to buy any security. Programme rules, statutory deadlines, and market terms change. Confirm anything you intend to rely on with advisers engaged on your specific facts.