What Does Debt-Service Coverage Ratio Mean?
By Rick Melero, Commercial Investor, Real Estate Mentor, Member of HIS Board of Advisor
Debt-Service Coverage
Ratio:
The DSCR is a ratio used to analyze
the amount of debt that can be supported by the cash flow
generated from the property. Simply put, it is the net income
generated by the property divided by the new annual commercial
mortgage payment.
Every commercial loan underwriter uses this important factor to determine the approvability of a commercial mortgage requested.
Example:
$100,000 (NOI) / $65,000 (Debt Service) =
1.538 (DSCR)
So... a DSCR of .9 indicates a negative income. This means that there is only enough income available after paying operating expenses to pay 90% of the annual debt service. This scenario would not be approved by any lending institution.
Now if a property has a DSCR of 1.25, it is generating 1.25 times as much annual income as the annual debt service on the property. This means that this property is generating 25%more income (NOI) than is required to cover the annual debt service.
Prudent investors always avoid being over leveraged with debt. This is why in most of our projects we raise more equity through private investors. By doing so, it enables us to create a margin of safety. We have also found that the more equity, the more competitive we can be in the market with our rental rates. More equity helps us to increase our occupancy rates when every other leveraged competitor can’t afford to match our rates.
Rick Melero
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