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What Is Debt Service Coverage Ratio?
In commercial real estate, the debt service coverage ratio — often shortened to DSCR or DCR — is the measurement of an asset or entity’s cash flow compared to its debt obligations.
If a commercial property’s DSCR is less than 1, it means the asset’s net operating income is less than its monthly debt obligations. Alternatively, if a property has a DSCR greater than 1, its income is greater than its monthly loan payments. In commercial lending, the higher the DSCR, the easier it is to obtain financing.
Commercial mortgage lenders scrutinize the debt service coverage ratio as a means of cash flow analysis. DSCR is highly valued by lenders because it’s one of the best predictors of a borrower’s ability to pay back a loan on time. In order to mitigate risk, most lenders and loan programs have DSCR requirements for prospective borrowers. In most cases, DSCRs of 1.25x or more are required. Technically, DSCR requirements are dependent on the combination of numerous factors, including the financial strength of the borrower and the type of property in question.
The formula for determining a commercial property’s debt service coverage ratio is:
DSCR = Net Operating Income (NOI) ÷ Annual Debt Obligations
DSCR Vs. Global DSCR
In some cases, like with small business commercial property loans and smaller multifamily loans, a lender may require more than the standard DSCR metric. In these cases, lenders may scrutinize what’s known as the global DSCR.
Global DSCR accounts for a borrower’s personal income and debts in addition to the property’s income and debts. Depending on the personal financial strength of the investor, this can be an advantage or a disadvantage. For instance, a borrower with higher income and low personal debt may have a global DSCR that is much higher than their property or business DSCR, while borrowers with lower income or a lot of credit card debt might be denied financing for the same deal.