Debt Coverage Ratio (DCR) is a measure of a property's ability to generate enough income to cover its debt obligations. It is calculated by dividing the net operating income (NOI) of a property by its total debt service (principal and interest payments). A higher DCR indicates that the property is generating more income than is necessary to cover its debt obligations, while a lower DCR indicates that the property is not generating enough income to cover its debt obligations.

In general, most lenders prefer a DCR/DSCR of at least 1.20x. However, certain types of loans will go below this. For instance, HUD multifamily loans, such as the HUD 221(d)(4) loan for multifamily construction and substantial rehabilitation, and the HUD 223(f) loan for multifamily acquisitions and refinancing, permit DCRs as low as 1.15x for affordable housing properties and as low as 1.11x for subsidized properties.

Despite the fact that certain loans have lower DCR eligibility limits, the higher your DCR, the easier it will be to get a commercial real estate loan on good terms— including longer, fixed-rate terms, lower interest rates, non-recourse provisions, lower fees, and smaller prepayment penalties with shorter durations.

In addition, it’s important to realize that lenders often require riskier types of properties to have significantly higher DCR. For instance, most lenders prefer hotel and self-storage properties to have a DCR of at least 1.40x, due to the fact that these property types have incredibly high turnover and revenues that can fluctuate greatly by season (and even by the day).

The debt coverage ratio (DCR) is calculated by dividing the net operating income (NOI) by the entity's annual debt service. The formula for calculating the debt service coverage ratio looks like this:

DSCR = Net Operating Income ÷ Annual Debt Service

For example, if the net operating income is $845,000 and the annual debt service is $758,475, the debt service coverage ratio would be 1.10x.

Debt service coverage ratios of at least 1.0x are considered to be in the breakeven range. At the same time, any figures below 1.0x would be a net operating loss for the prospective debt structure taken on by the entity.

In general, most lenders prefer a debt coverage ratio (DCR) or debt service coverage ratio (DSCR) of at least 1.20x. However, certain types of loans will go below this. For instance, HUD multifamily loans, such as the HUD 221(d)(4) loan for multifamily construction and substantial rehabilitation, and the HUD 223(f) loan for multifamily acquisitions and refinancing, permit DCRs as low as 1.15x for affordable housing properties and as low as 1.11x for subsidized properties.

Despite the fact that certain loans have lower DCR eligibility limits, the higher your DCR, the easier it will be to get a commercial real estate loan on good terms— including longer, fixed-rate terms, lower interest rates, non-recourse provisions, lower fees, and smaller prepayment penalties with shorter durations.

In addition, it’s important to realize that lenders often require riskier types of properties to have significantly higher DCR. For instance, most lenders prefer hotel and self-storage properties to have a DCR of at least 1.40x, due to the fact that these property types have incredibly high turnover and revenues that can fluctuate greatly by season (and even by the day).

Having a low debt coverage ratio (DCR) in commercial real estate can make it difficult to get a loan on good terms. Most lenders prefer a DCR of at least 1.20x, and certain types of loans may go below this. For instance, HUD multifamily loans, such as the HUD 221(d)(4) loan for multifamily construction and substantial rehabilitation, and the HUD 223(f) loan for multifamily acquisitions and refinancing, permit DCRs as low as 1.15x for affordable housing properties and as low as 1.11x for subsidized properties.

Having a low DCR can also mean that lenders require riskier types of properties to have significantly higher DCRs. For instance, most lenders prefer hotel and self-storage properties to have a DCR of at least 1.40x, due to the fact that these property types have incredibly high turnover and revenues that can fluctuate greatly by season (and even by the day).

If a property has a DCR of less than 1, it is actually losing money, which means that it will be ineligible for most kinds of commercial real estate financing, except for perhaps hard money loans or other types of high-interest, emergency loans.

Having a high debt coverage ratio (DCR) in commercial real estate can provide a number of benefits. A higher DCR can make it easier to get a commercial real estate loan on good terms, including longer, fixed-rate terms, lower interest rates, non-recourse provisions, lower fees, and smaller prepayment penalties with shorter durations. In addition, lenders often require riskier types of properties to have significantly higher DCR, such as hotel and self-storage properties which typically require a DCR of at least 1.40x.

Source: www.commercialrealestate.loans/commercial-real-estate-glossary/debt-coverage-ratio