Tien and Jim 

Your Real Estate Partners

Debt Coverage Ratio

 

             Also known as Debt Service Coverage Ratio (DSCR).  The debt coverage ratio is

             a widely used benchmark which measures an income producing property's ability 

             to cover the monthly mortgage payments.  The DCR is calculated by dividing the

             net operating income (NOI) by a properties annual debt service.  Annual debt

             service equals the annual total of all interest and principal paid for all loans on a  

             property.  A debt coverage ratio of less than 1 indicates that the income generated

             by a property is insufficient to cover the mortgage payments and operating expenses. 

             For example, a DCR of .9 indicates a negative income.  There is only enough income

             available after paying operating expenses to pay 90% of the annual mortgage payments

             or debt service.  A property with a DCR of 1.25 generates 1.25 times as much annual 

             income as the annual debt service on the property.  In this example, the property  

             creates 25% more income (NOI) than is required to cover the annual debt service.

 

             Example:  We are considering buying an investment property with a net operating

             income of $24,000 and annual debt service of $20,000.  The DCR for this property

             would be equal to 1.2.   This means that it generates 20% more annual net operating   

             income than is required to cover the annual mortgage payment amount.

 

                                                                 Net Operating Income              $24,000

                  Debt Coverage Ratio    =     ------------------------------      =     -----------       =    1.2

                                                                   Annual Debt Service               $20,000

 

             Many lending institutions require a minimum debt coverage ratio value to procure 

             a loan for income producing properties.   DCR requirements for lending institutions 

             may vary from as low as 1.1 to as high as 1.35.   From a lending institutions 

             perspective, the higher the DCR value, the more income there is available to cover 

             the debt service and thus the less the risk.

 

             Net Operating Income (NOI) is calculated as follows.

 

                 Income

                     Gross Rents Possible                       35,000

                     Other Income                                      2,000

                 Total Gross Income                              37,000

                     Less Vacancy Amount                        3,000

                 Gross Operating Income                      34,000

                     Less Operating Expenses                10,000

                  Net Operating Income                         24,000

 

             Operating Expenses include the following items; advertising, insurance, 

             maintenance, property taxes, property management, repairs, supplies, etc.

 

             Lenders use the debt coverage ratio to determine if an income producing property  

             has sufficient income to cover the operating expenses and debt service.  To acquire

             a loan for an income producing property, the debt coverage ratio must usually be

             greater than 1.1 and most lenders require a debt service coverage ratio greater

             than 1.2.