What is DSCR: the debt service coverage ratio?
The Debt Service Coverage Ratio or DSCR, is a comparison between net operating income and debt service on an annual basis and is generally one of the most important considerations when a commercial mortgage broker, lender or bank is underwriting a loan. For example, an commercial property with a net operating income of $1,000,000 and a debt service of $900,000 would have a DSCR of $1,000,000 / $900,000, or 1.11 (his income is 1.11x his annual debt service).
The general starting point on commercial mortgages is a 1.20xDSCR (but of course this number fluctuates depending on who the lender is, the property type, the submarket, amortization, etc.).
To calculate the net operating income, lenders will subtract gross income from anticipated operating expenses. Debt service would include a calculation of interest and principal payments given the life of the loan and fixed interest rate.
Often, DSCR is used by lenders to assess risk in approving a new loan. Some lenders prefer more stable measures of risk, such as the debt yield, which measures net operating income by the outstanding loan amount. In real estate, debt yield gives a more definitive timeline of recouping the loan funds in the event of foreclosure.
DSCR may change with manipulation of the loan terms, such as amortization, in order to increase or reduce annual debt service. The following formula will help you easily calculate the DSCR: Debt Service Coverage Ratio: