How Do I Calculate Debt Coverage Ratio (DCR)

Debt Service Coverage Ratio (DSCR)

Debt Coverage Ratio

Debt Coverage Ratio (DCR) or Debt Service Coverage Ratio (DSCR)

Debt Coverage Ratio, also known as Debt Service Coverage Ratio are terms that are used interchangeably by lenders to represent a key indicator to determine the financial viability of a commercial property purchase loan application.  The calculation is quite simple with a few basic variables known.

Frequently (but not exclusively) used in multi-family transactions, the debit coverage ratio measures the ability to pay the property’s monthly mortgage payments from the cash generated from renting the property.  Bankers and lenders use this ratio as a guide to help them understand whether the property will generate enough cash to pay rental expenses and whether you will have enough left over to pay them back on the money you borrowed.

The DCR is calculated by dividing the property’s annual net operating income (NOI) by a property’s annual debt service.  Annual debt service is the annual total of your mortgage payments (i.e. the principal and accrued interest, but not any funds collected into your escrow account).

Formula:

Debt Coverage Ratio (DCR or DSCR) = Net Operating Income (NOI) / Debt Payments (P&I)

A debt coverage ratio of less than 1, e.g. .75, indicates that there is not enough generated cash flow to pay the property’s operating and rental expenses and still have enough remaining to pay mortgage payments.  If the property had a debt coverage ratio of .75, this translates into the property only being able to cover 75% of the annual debt payments.

There may be extenuating circumstances, but obviously, a lender will seldom be willing to loan money to purchase a property if the property will not generate enough cash to pay the loan payments.

A debt coverage ratio (DCR) of greater than 1, e.g. 1.25, means that the property generates enough cash flow to cover its operating expenses plus an additional 25% more to cover the property’s debt payments.

Most lenders require a debt coverage ratio (DCR) of between 1.25 – 1.35.  This means the property must generate rental cash flow of between 25% – 35% more than it’s rental operating expenses to ensure cash flow sufficient to cover loan payments is available on an ongoing basis.

Peak Realty Advisors, a professional real estate brokerage affiliates with and recommends experts, each with specialties in associated areas including, legal, tax, funding, and escrow, all companies proven to serve as your resources to obtain accurate and thorough information about the entire real estate purchase process.

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