What is DSCR?
What is Debt Service Coverage Ratio (DSCR)?
Debt Service Coverage Ratio, often referred to as simply DSCR, is a measurement of an entity’s cash flow vs. its debt obligations. In multifamily and commercial real estate, that entity is typically an income-producing property, while in corporate finance, the entity is usually a business or corporation. In the most simple terms, if an entity has a DSCR of less than 1, then that means that its income is less than its monthly debt obligations. In contrast, if an entity has a DSCR of 1, then that equates to its income being equal to its monthly debt obligations. Finally, when the entity has a DSCR of more than 1, it means its income is greater than its monthly debts. It goes without saying that most (if not all) apartment loan programs have DSCR minimums that help to determine eligibility.
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 that they will take into account. This is because an entity's DSCR is one of the best predictors of whether a borrower will be able to pay back a loan on time (or at all). In most cases, lenders prefer properties with DSCRs of greater than or equal to 1.20x, though the required DSCR will typically depend on the financial strength of the borrower, the type of property in question, and other key factors. For example, while multifamily apartment properties may need a minimum DSCR of 1.20x to qualify for funding, riskier property types, such as hotels or self-storage facilities, may need a DSCR of 1.40x- 1.50x in order to qualify.
What is the Formula for DSCR?
In order to calculate the debt service coverage ratio for a commercial or multifamily property, you can use the formula: Net Operating Income/Debt Obligations. While this may seem like a simple enough equation, it’s essential to make sure you have ALL of the correct numbers before utilizing the formula.
Generally speaking, 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 a property or business. Debt Obligation refers to all debts (recurring and outstanding) to be paid by the entity, usually calculated annually. So, for example, if a property had a 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 Calculator
Regular DSCR vs. Global DSCR
For smaller multifamily loans, many lenders may utilize something called global DSCR. This simply means that they will take into account a borrower’s personal income and debts in conjunction with the property’s income and debts in order to calculate a broader DSCR. This can be very beneficial, or very frustrating, depending on the personal financial strength of the individual in question. For instance, someone with a high income and few personal debts may see that their global DSCR is much higher than their property or business DSCR, while someone with a low income and a lot of credit card debt would see their DSCR greatly decline using this calculation.
Related Questions
What is the definition of Debt Service Coverage Ratio (DSCR)?
Debt Service Coverage Ratio (DSCR) is a measurement of an entity’s cash flow vs. its debt obligations. In multifamily and commercial real estate, that entity is typically an income-producing property, while in corporate finance, the entity is usually a business or corporation. DSCR is defined as the cash flow necessary to pay debts - interest, principal, lease payments, etc. It is used by lenders to determine loans on income properties. The ratio is a formula that divides the net operating income of a business by the total debt service amount:
DSCR = Net Operating Income / Total Debt Service
So, a business with a DSCR of less than 1 does not have sufficient funds to pay back debt obligations, while a business with a DSCR of greater than 1 does.
How is DSCR used to evaluate apartment loan applications?
When a lender is evaluating a borrower for an apartment loan, the debt service coverage ratio (DSCR) is typically one of the most important factors that they will take into account. This is because an entity's DSCR is one of the best predictors of whether a borrower will be able to pay back a loan on time (or at all). In most cases, lenders prefer properties with DSCRs of greater than or equal to 1.20x, though the required DSCR will typically depend on the financial strength of the borrower, the type of property in question, and other key factors. For example, while multifamily apartment properties may need a minimum DSCR of 1.20x to qualify for funding, riskier property types, such as hotels or self-storage facilities, may need a DSCR of 1.40x- 1.50x in order to qualify. The main eligibility criteria for a DSCR loan are surrounding, understandably, the property’s debt service coverage ratio. Broadly speaking, DSCR financing is available for assets with a ratio of at least 1.25x. Every lender is different, however, and some may even offer financing for buildings with a DSCR of less than 1x — but expect those loans to be far more expensive and may require additional reserves.
What is the minimum DSCR required for an apartment loan?
The minimum DSCR required for an apartment loan is typically 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. For example, while multifamily apartment properties may need a minimum DSCR of 1.20x to qualify for funding, riskier property types, such as hotels or self-storage facilities, may need a DSCR of 1.40x- 1.50x in order to qualify. Borrowers should expect a DSCR requirement of at least 1.11x.
Source: https://apartment.loans/posts/what-is-dscr and https://www.hud.loans/fha-241a
What are the advantages of having a higher DSCR for an apartment loan?
Having a higher DSCR for an apartment loan can offer several advantages. According to this article, a higher DSCR can result in better loan terms for the borrower. Additionally, according to this article, a higher DSCR is typically one of the most important factors that lenders consider when evaluating a borrower for an apartment loan. Furthermore, according to this article, 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.
What are the risks of having a lower DSCR for an apartment loan?
The risks of having a lower DSCR for an apartment loan include the potential for the borrower to default on the loan, as well as the potential for the lender to incur losses if the borrower is unable to pay back the loan. Additionally, having a lower DSCR may make it more difficult for the borrower to qualify for a loan, as lenders typically prefer properties with DSCRs of greater than or equal to 1.20x. (Source)