Most long-term commercial real estate loans are based on their debt service covereage ratio (DSCR). DSCR is a key metric used to measure the ability of a property to generate enough income to cover its debt obligations. In other words, it shows how much cash flow a property has available to pay its mortgage.
Why is DSCR Important?
Lenders use DSCR to assess the risk of lending money for a particular property. A higher DSCR indicates a lower risk, as it shows that the property is generating more than enough income to cover its debt payments. A lower DSCR indicates a higher risk, as it shows that the property may not generate enough income to cover its debt payments. DSCR is a major factor in determining the interest rate for rental property loans, multi-family loans and blanket portfolio loans.
How to Calculate DSCR
The formula for calculating DSCR is simple:
DSCR = Net Operating Income (NOI) / Debt Service- Net Operating Income (NOI) is the property’s income after all operating expenses have been paid. This includes property taxes, hazard insurance and HOA fees.
- Debt Service is the total amount of money that must be paid to service the debt on the property. This includes principal and interest payments.
DSCR Calculation Example
Let’s say you’re considering purchasing a multi-family property with an NOI of $100,000 and a debt service of $80,000. The DSCR for this property would be:
DSCR = $100,000 / $80,000 = 1.25This means that the property generates 1.25 times the amount of income needed to cover its debt payments.
What is a Good DSCR?
Lenders typically look for a DSCR of 1.25 or higher. This indicates that the property is generating a healthy amount of cash flow and is at low risk of default. However, the ideal DSCR will vary depending on the lender, the type of property, and the overall market conditions. For example, at Little City Investments, we can go as low as 0.8 DSCR for qualified borrowers with single-family properties. And we can go as low as a DSCR of 1 for multi-family and mixed use properties.
How to Improve DSCR
If a property has a low DSCR, there are a few things that can be done to improve it. One option is to increase the property’s income. This can be done by raising rents or finding new tenants. Another option is to decrease the property’s expenses. This can be done by refinancing the debt to a lower interest rate or by finding ways to reduce operating costs.
Conclusion
DSCR is an important metric to understand when it comes to commercial real estate lending. By understanding how to calculate DSCR and what a good DSCR is, you can make informed decisions about your investments.
At Little City Investments, we want to be your go-to lender for Texas DSCR real estate loans. Our terms are ulta-competitive and we have flexible requirements for qualifying. Contact us today if you have questions about how to calculate DSCR for your property.