What Is DSCR (Debt Service Coverage Ratio)?
DSCR, or debt service coverage ratio, is a measurement of a property’s cash flow compared to the amount of money needed to pay current debts like interest, principal, and lease payments. DSCR is one of the most important metrics used by lenders to determine an income generating property’s eligibility for a loan.Start Your Application and Unlock the Power of Choice$5.6M offered by a Bank at 6.1%$1.2M offered by a Bank at 6.0%$2M offered by an Agency at 5.6%$1.4M offered by a Credit Union at 6.1%Click Here to Get Quotes!
DSCR (Debt Service Coverage Ratio) in Relation to HUD 221(d)(4) Loans
DSCR, or debt service coverage ratio, is a measurement of a property’s cash flow compared to the amount of money needed to pay current debts like interest, principal, and lease payments. DSCR is one of the most important metrics used by lenders to determine an income generating property’s eligibility for a loan.
For HUD 221(d)(4) loans, DSCR requirements are:
1.20x for market-rate properties
1.15x for affordable housing properties
1.11x for rental assistance properties
To learn more about HUD multifamily construction loans like the HUD 221(d)(4) loan, fill out the form below and a HUD lending expert will get in touch.
What is the definition of DSCR in commercial real estate?
Debt Service Coverage Ratio (DSCR) is a measurement of an entity’s cash flow versus its debt obligations. In commercial real estate, that entity is typically an income-producing property. DSCR is calculated by dividing the net operating income (NOI) of the property by the total debt service (TDS) of the loan. If the DSCR is less than 1, then that means that the income is less than the monthly debt obligations. If the DSCR is 1, then that equates to the income being equal to the monthly debt obligations. Finally, when the DSCR is more than 1, it means the income is greater than the monthly debts. Most apartment loan programs have DSCR minimums that help to determine eligibility.
How is DSCR used to evaluate a commercial real estate loan?
Debt Service Coverage Ratio (DSCR) is used to evaluate a commercial real estate loan by measuring a property's cash flows relative to its debt service obligations. A lender can determine if a property generates enough net income to cover its debt obligations by using a DSCR calculation. DSCR requirements vary by asset type, but the higher the better. Don't expect to find many institutions willing to offer you a competitive loan at a DSCR of less than 1.25x. (Source, Source)
What is the formula for calculating DSCR?
The formula for calculating debt service coverage ratio is fairly straightforward, given below:
DSCR = Net Operating Income ÷ Debt Obligations
In order to calculate the debt service coverage ratio for a multifamily property, you simply divide the asset’s net operating income by its debt obligations.
What is a good DSCR for a commercial real estate loan?
In most cases, lenders prefer properties with DSCRs of 1.25x or more, though the required DSCR will typically depend on the financial strength of the borrower, the type of property in question, and other factors. For instance, while multifamily apartment properties may need a minimum DSCR of 1.25x 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. Source and Source.
What are the risks of having a low DSCR for a commercial real estate loan?
Having a low DSCR for a commercial real estate loan can be risky because it indicates that the property's cash flows are not sufficient to cover its debt service obligations. This means that the borrower may not be able to make their loan payments, which could lead to default. Additionally, lenders may be less likely to offer competitive loan terms if the DSCR is too low. Generally, lenders look for a minimum DSCR of 1.25x. Source
What are the benefits of having a high DSCR for a commercial real estate loan?
The main benefit of having a high debt service coverage ratio (DSCR) for a commercial real estate loan is that it can lead to better loan terms. A higher DSCR indicates that the property is generating a higher net operating income, which is a sign of lower risk to the lender. As a result, borrowers with a higher DSCR may receive more competitive interest rates and longer loan terms. For example, some lenders may offer loans of up to 35 years for properties with a high DSCR. Additionally, DSCR loans may allow for unlimited cash out, which can be useful in the event of an unexpected or large property expense.