What is the debt service coverage ratio (DSCR)?
The debt service coverage ratio (DSCR) is the relationship between a property’s annual net operating income and its annual mortgage debt.
How do I calculate the debt service coverage ratio (DSCR)?
To calculate the debt service coverage ratio (DSCR) you divide the annual net operating income by the annual mortgage debt.
What is the debt service coverage ratio (DSCR) used for?
The debt service coverage ratio is used to determine if there is enough income available to pay the mortgage debt. Or, simply put, the DSCR on an income producing property is an indication of how strong a property’s cash flow is. The higher the DSCR the stronger and more profitable a property is.
Why does the debt service coverage (DSCR) matter?
The debt service coverage ratio is the most important ratio used by lenders as it provides an indication of a property’s ability, after paying all other expenses, to service the mortgage debt. For example, a property with a DSCR of 1.50 means that after paying all operating expenses a property can cover the mortgage payment by 1.5 times or 150%. Whereas a property with a 1.00 DSCR means that after paying all operating expenses and the mortgage debt there is no money left over. A lender requires there to be money left over after paying all expenses and mortgage debt to provide a buffer to ensure there is enough cash flow available to pay the mortgage payment in case expenses rise or income falls.
Now that we have calculated the NOI, we must calculate the annual debt service for the property. The annual debt service is the simply the total amount of principal and interest payments made over a 12 month period. Taxes and insurance are not included in this calculation as they are accounted for in the expenses of the property.
To calculate the debt service coverage ratio, simply divide the net operating income (NOI) by the annual debt.
Commercial Loan Size: $10,000,000
Interest Rate: 6.5%
Term: 30 Years
Annual Payments (Debt Service) = $758,475
Net Operating Income (NOI) = $845,000
Now we can calculate the DSCR:
DSCR = Net Operating Income / Annual Debt Service
(NOI) = $845,000
Total Debt Service = $758,475
DSCR = 1.10 ($845,000 / $758,475)
What this example tells us is that the cash flow generated by the property will cover the new commercial loan payment by 1.10x. This is generally lower than most commercial mortgage lenders require. Most lenders will require a minimum DSCR of 1.20x.
If a DSCR is 1.0x, this is called breakeven, and a DSCR below 1.0x would signal a net operating loss based on the proposed debt structure.
