Debt Coverage Ratio (DCR) &
Debt Service Coverage Ratio (DSCR)
Real Estate Definitions for Real Estate Investing
Debt Coverage Ratio (DCR) or Debt Service Coverage Ratio (DSCR)
The debt coverage ratio measures the ability to pay the property’s monthly mortgage payments from the cash generated from renting the property. Bankers and lenders use this ratio as a guide to help them understand whether the property will generate enough cash to pay rental expenses and whether you will have enough left over to pay them back on the money you borrowed.
The DCR is calculated by dividing the property’s annual net operating income (NOI) by a property’s annual debt service. Annual debt service is the annual total of your mortgage payments (i.e. the principal and accrued interest, but not your escrow payments).
Debt Cover Ratio (DCR) =
Net Operating Income / Debt Payments
Debt Coverage Ratio (DCR) Example:
Assume NOI of $20,000 and debt payments of $15,000. The DCR is 1.33, ($20,000/$15,000 = 1.33).
In this example, the DCR of 1.33 means that the property will generate 1.33 times more (or 33% more) in cash that is required to pay the mortgage payments.
A debt coverage ratio of less than 1, e.g. .75, indicates that there is not enough generated cash flow to pay the property’s operating and rental expenses and still have enough remaining to pay mortgage payments. If the property had a debt cover ratio of .75, this translates into the property only being able to cover 75% of the annual debt payments.
Obviously, a lender will not be willing to loan money to purchase a property if the property will not generate enough cash to pay the loan payments.
A debt coverage ratio (DCR) of greater than 1, e.g. 1.25, means that the property generates enough cash flow to cover its operating expenses plus an additional 25% more to cover the properties debt payments.
Most lenders require a debt coverage ratio (DCR) of between 1.25 – 1.35. This means the property must generate rental cash flow of between 25% – 35% more than it’s rental operating expenses to ensure cash flow sufficient to cover loan payments is available on an ongoing basis.
Our real estate investment software calculates the Debt Coverage Ratio (DCR) so that you are in a better position of understating how much to offer for a particular property and make the appropriate presentations to bankers, lenders and prospective real estate partners.