Debt service coverage ratio or DSCR (also known as debt coverage ratio or DCR) is a comparison between a property’s income and its expenses.
It’s one of the most important numbers lenders examine to approve you for a multifamily loan. It tells the lender (and you) whether the property brings in enough income to support the future loan payments.
Here’s the formula:
NOI (Net Operating Income) / Debt Service (Loan Payments) = DSCR
The first part of this calculation is NOI or net operating income. You find this by looking at actual income over the previous 12 months and subtracting actual expenses.
Let’s say a property brought in $140,000 over the last 12 months and had $80,000 in expenses. NOI would be $60,000.
Now let’s say the loan payments were $52,000 per year. Plugging that into the formula, we get:
$60,000 (NOI) / $52,000 (debt service) = 1.15x DSCR
This DSCR is a bit low. Most lenders want to see 1.25x or more. In this case, we might look at taking a bigger prepayment penalty to get a lower rate. Then we could put another 5% down to lower the loan amount. Now we have a $48,000 in yearly debt service payments.
$60,000 (NOI) / $48,000 (debt service) = 1.25x DSCR
We made it! You could also present to the lender with quick opportunities to bring up revenue and cut expenses. You would increase NOI and DSCR, perhaps without having to put more down.
How DSCR Affects Apartment Loan Qualification
For a commercial loan, the lender qualifies the loan based on the property’s income. This is different than residential lending, in which the lender looks at the borrower’s income for qualification.
As mentioned, most lenders want to see a DSCR of 1.25x or more, but some will go lower.
Remember that where you get your NOI number is important. You typically can’t use future income unless the lender approves it and you make a good case for how you will increase NOI. The most conservative way to calculate NOI is taking actual revenues from the last 12 months, less actual expenses.
But what counts as actual revenues? You can count things like:
- Laundry facilities
- Vending machines
- Parking fees
For expenses, calculate things like management service costs, taxes, utilities, and other regular costs of running the property. You do not count one-time expenses like a new roof.
DSCR is one of the most important numbers to know (and be able to calculate) when looking at multifamily properties. It pays to spend the time becoming an expert at reviewing the property’s financials, finding its DSCR, and determining if it’s a quality property that can obtain financing.