DCR: Debt Coverage Ratio
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What is debt coverage ratio (DCR)?
DCR, a shortened version of Debt Coverage Ratio, more commonly known as Debt Service Coverage Ratio (DSCR), is a calculation that measures a property’s income as compared to its debt obligations. This metric is utilized by lenders in order to determine if a borrower is able to repay their debts. In apartment finance transactions, properties with a DCR of 1 or higher are considered to be profitable, whereas those with DCRs lower than 1 are considered to not be profitable.
DCR = Net Operating Income (NOI)/Debt Obligations.
To properly calculate DCR, despite the simplicity of the formula, an investor will need to make sure they are using the correct figures in order to get an accurate debt coverage ratio for a property.
In regards to getting an accurate DCR metric, Net Operating Income/NOI is typically calculated using earnings before interest, taxes, depreciation, and amortization (EBITDA). This means that taxes, interest, or other costs from the NOI calculation should NOT be deducted before entering it into the DCR formula.
The following example shows how the DCR formula is used in practice:
A multifamily property has an NOI of $3,500,000, and annual debt obligations of $2,700,000. In that case, it would have a DCR/DSCR of:
$3,500,000/$2,700,000 = 1.30x DCR
In most apartment loan transactions, this would be considered a good DCR by the lender.
DCR in Apartment Finance
Adjacent to Loan to Value and Loan to Cost ratios, a property’s DCR (more often called DSCR) is a crucial part of the loan decision-making process. DCR is a key factor in how a lender determines the risk of issuing a loan. If the DCR is below the preferred criteria for the loan product, lenders will automatically assume that the borrower will have difficulty paying back their loan on time.
Most apartment finance lenders have adapted to the importance of a good DCR, by setting DCR requirements, with the most common DCR requirement at 1.25x for most apartment loans. Even so, properties that have lower LTVs may still be able to qualify for funding even if they have a lower DCR. The general safety of a given property type can also assist a borrower in qualifying for loans with lower DCRs. For example, hotels or motels are considered to be of a higher risk, and might need a 1.30-1.50x DSCR in order to qualify for funding. Alternatively, traditional multifamily or commercial properties are considered to be much safer, and may only need to be around 1.20x.
What is Global DCR?
In some cases, the standard DCR metric may not be enough information for the lender. In these cases, Global DCR is often used. Global DCR is a variation of the DCR formula that factors in a borrower’s personal finances (income and debts) into the calculation. In most cases, Global DCR is typically only requested of small business owners, including “small” multifamily and commercial real estate investors. Lenders will want a more detailed idea of the DCR for these transactions to determine if the investor in this case is biting off more than they can chew. Borrowers who have a high income compared to their debt, generally benefit from a global DCR calculation, while borrowers with lower income and higher personal debts will have a much harder time obtaining a commercial or multifamily real estate loan.
Business DCR and Property DCR
When it comes to determining eligibility for CMBS, life company, HUD multifamily, and other asset-based multifamily loans, the financials of the target property receive the most scrutiny (though HUD and Freddie Mac/Fannie Mae do set requirements for borrower financials). Lenders look at the property DCR to make sure that an income producing property is able to perform adequately enough to be able to cover the costs of the loan.
In cases revolving around small business owners seeking an SBA loan, like the SBA 7(a) or SBA 504 loan, lenders will often scrutinize the DCR of the business in question. The SBA typically requires that SBA 7(a) borrowers have a business DSCR of no less than 1.15x to meet eligibility requirements. Business DCR is a common consideration in most business financing transactions, even outside of SBA products.
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- What is global DCR?
- Global DCR is a variation of debt coverage ratio, or DCR, that factors in a borrower’s personal finances (income and debts) into the calculation. Global DCR is typically only requested by lenders in cases where more detailed information about a borrower’s ability to repay debt is needed.
- What is a property's DCR?
- A property's debt coverage ratio is a calculation that measures a property's income compared to its debt obligations. Lenders utilize this metric to determine if an asset generates enough money to cover debt obligations. A property with a DCR of 1 or higher is considered to be profitable, though lenders usually require much higher ratios.
- How is net operating income or NOI calculated?
- Net operating income, or NOI, is typically calculated similarly to earnings before interest, taxes, depreciation, and amortization (EBITDA). This means that taxes, interest, or other costs from the NOI calculation should not be deducted as part of operating expenses.Learn more →