Looking to apply for a real estate loan? One of the most important calculations you need to know when applying for a real estate loan is the “debt-service coverage ratio.” This ratio determines how much loan you can get by measuring your property’s net worth and your debt obligations.
What is Debt-Service Coverage Ratio?
The debt-service coverage ratio or DSCR is applicable in various contexts, including government, corporate, personal finance, and real estate. In the corporate finance context, the debt-service coverage ratio refers to the available cash flow the business has to pay its debt obligations. The DSCR indicates the financial health of the corporation to its investors, who can assess whether the company’s earnings are adequate to clear its debts. DSCR in government finance refers to export earnings that a country needs to make payments related to its external debt.
DSCR in real estate
In the real estate context, the debt service coverage ratio is a measurement of the relationship between the property’s NOI and its mortgage debt service.
The DSCR is used by commercial lenders to determine how much of a loan the multifamily or commercial property can support. This ratio can help predict if the borrower will be able to repay the loan promptly.
How to calculate DSCR?
The formula used for calculating DSCR is:
Net Operating Income/Debt Obligations
NOI is calculated using EBITDA or earnings before interest, tax, depreciation, and amortization. Total debt obligations include all the debt obligations, including interest, lease payments, principal and sinking fund due in the next year.
If the NOI of a property is $1,000,000 and its debt obligations are $800,000, the DSCR would be:
1,000,000/800,000 = 1.25
Commercial lenders typically prefer a DSCR of 1.20 or more, although the DSCR depends on the borrower’s financial strength, the property type, and other elements. A DSCR of at least 1.20 may be needed for multifamily apartment properties, while riskier properties such as hotels may need a higher DSCR of 1.40 or more to qualify for loans.
Regular and Global DSCR
Some lenders provide real estate loans based on global DSCR. A global DSCR ratio combines both income and expenses from the property as well as personal income. This enables a property in a lower capitalization area or weak cash flow to qualify for the loan. In this case, the borrower’s personal income has to be adequate to augment the NOI of the property.
A borrower with few personal debts and high income may have a higher global DSCR as compared to the DSCR of their property, while a person with a lot of debts and low income will have a low DSCR.One of the common reasons behind a commercial loan getting rejected is because the property fails to meet the DSCR requirements of the lender. Understanding the DSCR calculation and the factors that can lower the DSCR value is import
-The Multifamily Team
Hi, my name is Michael Avent. I founded The Multifamily Review in 2020. I’m a Commercial Agent at Northcap Multifamily located in Las Vegas, Nevada. My vision for The Multifamily Review is to be the most trusted resource for all Multifamily Investors and Industry Professionals. We strive to offer the best and most up to date content to our readers and are always open for suggestions. Make sure you sign up to join our newsletter to stay up to date on our latest blog, ebook, and more exclusive content that’s coming your way! The Multifamily Review team and I look forward to building a deeper relationship with you!
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