Commercial Mortgage Quick Reference Guide
Debt Service Coverage Ratio (DSCR)
Debt Service Coverage Ratio, or DSCR, is a measurement of an entity’s cash flow vs. its debt obligations. In multifamily and commercial real estate, that entity is typically an income-producing property, while in corporate finance, the entity is usually a business or corporation. If an entity has a DSCR less than 1, its income is less than its monthly debt obligations. In contrast, if an entity has a DSCR of 1, then its income is equal to its monthly debt obligations, while if it has a DSCR of more than 1, its income is greater than its monthly debts.
DSCR in Relation to Multifamily and Commercial Real Estate Loans
When a lender is evaluating a borrower for a multifamily or commercial real estate loan, DSCR is one of the most important factors that they will take into account. This is because it’s one of the best predictors of whether a borrower will be able to pay back a loan on time. In most cases, lenders prefer properties with DSCRs of 1.20x 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 1.20x 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.
What is the Formula for DSCR?
In order to calculate DSCR for a commercial or multifamily property, you can use the formula: Net Operating Income/Debt Obligations. While this may seem simple, it’s essential to make sure you have the correct numbers before utilizing the formula.
In general, Net Operating Income (NOI) for the DSCR formula is calculated using EBITDA (earnings before interest, tax, depreciation, and amortization), so it’s essential to understand this when calculating the DSCR for your property or business. For example, if a property had a NOI of $1,000,000, and an annual debt obligation of $850,000, it would have a DSCR of:
1,000,000/850,000 = 1.18x DSCR
Business DSCR is More Important for SBA 7(a) and SBA 504 Loans
If you’re interested in CMBS financing for a multifamily or commercial property, lenders will typically only look at the asset at hand— in this case, the multifamily or commercial property you want to purchase or refinance. However, if you want SBA 7(a) or SBA 504 loan to purchase owner-occupied commercial real estate, lenders will focus on the DSCR of your business itself, rather than the property. While it’s true that you can rent out a certain part of your property out to tenants (between 40-49% of the property for SBA 504 loans), this is much less important than the actual profitability of your business itself.
Regular DSCR vs. Global DSCR
For small business commercial property loans, as well as for smaller multifamily loans, many lenders may take into account something called global DSCR. This simply means that they will use a borrower’s personal income and debts (in addition to the property’s income and debts) in order to calculate DSCR. This can be very beneficial, or very frustrating, depending on the personal financial strength of the individual in question. For instance, someone with a high income and few personal debts may see that their global DSCR is much higher than their property or business DSCR, while someone with a low income and a lot of credit card debt would see their DSCR greatly decline using this calculation.