What is Debt Service Coverage Ratio or DSCR (and Why Does it Matter)?

by Dena Landon, posted in Stessa News

A Debt Service Coverage Ratio or DSCR compares two things: The operating income real estate investors have available to service their debt versus their overall debt levels. To calculate your DSCR, simply divide your Net Operating Income or NOI for each property by your corresponding debt payments, on either a monthly, quarterly, or annual basis (or let Stessa calculate these and other metrics for you automatically).

Net Operating Income / Debt Payments = DSCR

If you’re interested in refinancing an existing property or buying a new one and need a mortgage, lenders pay close attention to your Debt Service Coverage Ratio or DSCR. It’s a valuable metric for loan officers to use to evaluate if your deal is a good investment or not. Why?

Lenders look at your DSCR to gauge your repayment ability. If you don’t have enough operating income to make your debt payments on mortgages or other loans, then it’s not a good investment for you or the bank. Usually lenders want a DSCR of 1.1 – 1.4 depending on the asset class and lending environment.

To get more specific, any number under 1x is less than ideal. For example, a DSCR of .95 means that there is only enough Net Operating Income to cover 95% of annual debt payments. Which isn’t a sustainable business model unless you have other sources of cash you can pull from.

Here’s an example: Let’s say a real estate developer is looking to obtain a mortgage loan from a local bank. 

The developer indicates that her Net Operating Income will be $25,000 per year and the lender notes that debt service will be $13,500 per year. The DSCR can thus be calculated as 1.85x, which should mean the borrower can cover her debt service nearly 2 times over given their operating income.

Now let’s look at an actual case study from a Stessa investor.

Chris has a single family home in Kansas City on Kevin’s Way that we’ll use to calculate his DSCR. His Net Operating Income (annually) is $15,660. His Debt Service (annually) is $9,617. So:

$15,660 / $9,617 = 1.6 DSCR

The DSCR for Chris’ Kevins Way property is 1.6, a very healthy ratio that allows him to cover all his debt payments and still have room for capital expenses, rain day funds, vacancies, et cetera.

Want to learn other important metrics that every real estate investor should know? Read on here or watch our video tutorial.