Debt Service Coverage Ratio (DSCR)
Debt Service Coverage Ratio, or DSCR, is a measurement of a property’s cash flow vs.its debt obligations. In multifamily real estate, that entity is typically an income-producing property. The rule of thumb is that when an entity is shown to have a DSCR of less than 1, then that means that its income is less than its monthly debt obligations. In contrast, if a property has a DSCR of exactly 1, then that means its income is equal to its monthly debt obligations. Finally, when a property has a DSCR of more than 1, it means its income is greater than its monthly debts. Most apartment loan programs have DSCR minimums in place that help to determine eligibility.
What is the Formula for DSCR?
In order to calculate the debt service coverage ratio for a multifamily property, you can use the formula: Net Operating Income/Debt Obligations. It’s essential to make sure you have ALL of the correct numbers before utilizing the formula.
Net Operating Income (NOI) for the DSCR formula is calculated using EBITDA (earnings before interest, tax, depreciation, and amortization), so it’s essential to understand this when calculating the DSCR for an apartment property. Debt Obligation encompasses all debts (recurring and outstanding) to be paid by the entity, usually calculated annually.
So, for example, if a property has an NOI of $1,000,000, and an annual debt obligation of $850,000, it would have a DSCR of:
1,000,000/850,000 = 1.18x DSCR
DSCR in Relation to Apartment Loans
When a lender is evaluating a borrower for an apartment loan, the debt service coverage ratio is typically one of the most important factors, if not THE most important factor that gets considered in a loan transaction. Lenders scrutinize a property's DSCR as one of the best predictors of whether a borrower will be able to pay back a loan sum. Many apartment loan programs set their minimum DSCR requirement at 1.25x, though in practice, the required DSCR will typically depend on the financial strength of the borrower, the type of property in question, and other key factors.