The debt service coverage ratio (DSCR) is a number that is crucial for real estate investors to know on a property that they are interested in if they want to get a loan from institutional lenders. The main reason this ratio is so important is because it measures the profitability of the property.
What Exactly Does This Ratio Measure?
The DSCR is the ratio of a property’s Net Operating Income (NOI) to its debt payments (the principal and interest). On top of this, the ratio can be calculated using annual, quarterly, or monthly numbers.
NOI / Debt = DSCR
The higher this number, the easier it will be for the real estate investor to receive a loan. However, if this ratio is low, it will be much more difficult for the investor to get a loan on the property from lenders.
Why Does This Matter To Institutional Lenders?
Through the lens of the investor, profitability is the most important metric from the DSCR. However, lenders aren’t looking through the same lens. To lenders, the DSCR represents the ability and timeliness of investors to pay back their loan, and if they deem the investor unfit for the loan, the investment isn’t a great one for the lender or the investor.
For example, you, the reader, find a four-unit property right in the heart of East Nashville, and you want to mortgage it and rent it out. The current tenants pay $1200/mo each and the monthly mortgage payment is $2600. If you follow the formula, you will find that DSCR is about 1.85. This means that you could cover your debt almost twice, which is excellent news for you and the lender.