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Calculating Debt Service Coverage Ratio

Writer's picture: Jesse BrewerJesse Brewer


If you invest in commercial real estate, you may have heard the term debt service coverage ratio (DSCR), which is the property’s ability to cover its mortgage. 


DSCR is a key factor that lenders and investors consider when assessing a property’s financial health. Lenders will have minimum DSCR requirements based on the loan project the borrower is seeking and will take into account not only the DSCR of the property but the global DSCR of the borrower(s) themselves, meaning that if you have a property that does not cash flow well but has a lot of potential upside to increase the value and cash flows, they lender can consider the financial strength of the borrower as a whole to make up for the properties lack of performance. On the other hand, the adverse can come into play as well if you have a property with great DSCR, but the borrower is not so strong and can pull the property down then the lender may not want to make the loan or require additional collateral or equity (down payment) be put into the transaction. 



Now that you know what DSCR is, let’s look at how to calculate it. The formula is not as complex as it sounds, and we will look at how to calculate the DSCR of a property as well as an investor globally that has multiple properties. 


Step 1 – calculate the property's Net Operating Income (NOI)  

Step 2 – Determine the annual debt service (loan payment) and include the principal and interest payments.

Step 3 – Divide the NOI by the annual debt service.

Step 4 – Multiply by 100 to convert the DSCR from a decimal to a percentage. 


For example, let’s say a property generates an annual NOI of $500,000 and it has a yearly mortgage payment of $400,000.  Using the DSCR formula, you would do the following: 

$500,000 / $400,000 = 1.25.    The DSCR is represented by “x” after its value.  


Most lenders want to see a debt service coverage ratio on a property of greater than 1; however, when you are looking for larger commercial-type loans, the lenders want to see a DCSR of greater than 1.2.   



When calculating the DSCR of a potential investment, it is important to put in good data to determine the properties NOI.  A lot of investors will rely upon the seller's financials for this, and that is a mistake.  As an investor, you must use expense numbers that you would incur while operating the property.  This means accounting for things like property taxes reassessing to the new tax value, increased insurance cost, and other expenses such as 3rd party property management (if you are using one), allowing for a market correct vacancy allotment, etc.   


So, to calculate an investor’s global DSCR, you would use the same formula as for a property; however, you are using the investor’s total net operating income and dividing it out by the annual debt service payments.  If you need to calculate a DSCR on an individual to determine their ability for a residential mortgage loan application, you would take the individual's total gross income (including all their wages, pensions, dividends, rental income (NOI), interest earned) and divide that out by their total debt service obligations, which includes principal and interest on any mortgage, car loan, boat loan or anything with debt payment.  What this does is essentially give a picture of how well their overall income can cover all their debt payments from different sources.  


The formula would look like this:  GDSCR = total gross income / total debt service.


A higher GDSCR means that the borrower has a greater ability to manage debt levels and shows an ability to be able to repay, whereas a lower GDSCR could mean the opposite.  Different lenders require different levels of GDSCR for different loan programs.  It’s best to have an idea of your GDSCR when looking for a home or investment property so you can be more equipped to secure financing when you need it, making you a more prepared borrower and able to execute the transaction.

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