Investors Toolbox: DSCR

Depending on your strategy, the simple debt-service coverage ratio (DSCR) could be the straw that breaks the camel’s back when taking a hard look at the financials of a property.

Defined: Debt-Service Coverage Ratio (DSCR) is a ratio between the net income of the property and its total debt service (principal plus interest)

Key 1: When you think DSCR, think cash flow when:

· Determining how much cash flow is available for paying the debt on a property

(i.e. For current property)

· Determining if another property can realistically manage the costs of its debt

(i.e. Tax Deferred 1031 Exchange)

· Determining how credit-worthy a lender would consider the property

(i.e. Choosing a new acquisition)

Key 2: When calculating DSCR, first you need the following ingredients in your formula:

· Calculate the net income of the property

· Calculate the total debt service of the property, which includes principal + interest

Key 3: Is the DSCR < or > 1?

· DSCR < 1 = negative cash flow

· DSCR = 1 is considered breakeven

· DSCR > 1 = positive cash flow

Let's look at some examples.

Equation: DSCR = Annual NOI/Total Debt Service {principal + interest}

Example 1: You, the investor, want to know if a new investment opportunity is in the black or in the red regarding the cash flow coverage of its loans. The NOI is $500K, the principal on the loan is $450K and the interest is $100K.

DSCR = $500,000 / ($450K + $100K) = .91

With a DSCR of .91, this property is probably taking in less money than it pays out to its creditors.

Example 2: You’ve gone to a commercial lender about securing a $500K loan to acquire a MHP with an NOI of $72,000. The lender requires a minimum 1.20 DSCR for a property to be eligible for competitive financing.

Commercial loan purchase price: $500,000

Interest rate: 10%

Term: Interest only

Annual payments (debt service): $50,000

DSCR = $72,000 / $50,000 = 1.44

Cash flow generated by the MHP property will cover the new commercial loan payment by 1.44 times and exceeds this lender’s minimum DSCR for competitive financing.