3 min read
Key takeaways
- The debt service coverage ratio (DSCR) measures whether a property's net operating income (NOI) is sufficient to cover its annual debt service payments.
- Lenders use DSCR at both the property and portfolio level when evaluating commercial term loan applications, including loan sizing and eligibility.
- Accurately calculating NOI is essential: An inflated or understated NOI will distort the DSCR and misrepresent a property's debt-servicing capacity.
What is DSCR?
Debt service coverage ratio, or DSCR, measures whether a commercial real estate property's income is sufficient to cover its debt payments. In real estate, DSCR quantifies how easily the net income a property generates covers its mortgage obligations. Real estate investors use DSCR to evaluate potential investment properties and assess financing viability. Lenders also use DSCR when underwriting loans on multifamily buildings or other commercial properties, including when determining loan size and eligibility.
How to calculate DSCR
DSCR = net operating income (NOI) / total debt service
DSCR can be calculated at the property level or across an entire portfolio, known as global DSCR. Global DSCR includes a real estate investor's total NOI and debt service across all properties they own.
To calculate DSCR, divide the property's annual NOI by its annual debt service—the total of principal and interest payments due in a year. For instance, a property generating $450,000 in NOI with $250,000 in annual debt service payments would have a DSCR of 1.8, meaning there is $1.80 of income for every $1 of debt service.
Why does DSCR matter for commercial properties?
| Audience | Why DSCR matters |
|---|---|
| Investors | Purchase decisions |
| Owners | Profitability |
| Operators | Rent and occupancy decisions |
| Lenders | Debt obligation coverage |
How to calculate net operating income (NOI)
NOI = total income – total operating expenses
When calculating NOI, certain costs are excluded from operating expenses:
- One-time capital projects, such as replacing a roof, are typically excluded. Instead, investors factor in a set annual amount to cover capital expenditures as they arise.
- Expenses unrelated to property operations, including loan payments, are also excluded.
Accurately assessing NOI is important. An inflated NOI will overestimate a property's ability to cover mortgage payments, while an NOI that's too low underestimates the income available to service debt.
How lenders and investors use DSCR
Both real estate investors and lenders use DSCR to assess whether a rental property's operating cash flow can sustainably support its debt, or the debt required to acquire or refinance a property. A property's DSCR can also change over time if its NOI rises or falls.
What's a good DSCR?
DSCR benchmarks vary by lender, property type and market—there is no universal threshold.
| DSCR | What it means |
|---|---|
| <1 | The property is not generating enough NOI to cover principal and interest payments. |
| =1 | Operating cash flow covers debt payments—but just barely. There’s no income remaining for the owner and no cushion if vacancies or expenses increase. |
| >1 | The higher the DSCR, the more comfortably the property's NOI covers its debt service. |
How lenders use DSCR in loan underwriting
Lenders consider the DSCR at both the property and portfolio level when assessing a real estate investor's loan application. At the property level, DSCR is one factor in determining loan eligibility and the size of the loan offered. Understanding a lender's minimum DSCR requirements can help investors evaluate potential acquisitions and structure financing strategies accordingly.
Global DSCR and portfolio management
Looking at global DSCR can offer insights into how an investor is managing income and debt across their full portfolio of rental properties, and how acquiring or refinancing a property could influence that balance. Global DSCR can also be useful for understanding how changes in interest rates could affect an investor's portfolio, particularly if the investor has properties with adjustable-rate mortgages.
Digital banking platforms can help commercial real estate businesses gain more visibility into cash flow and improve efficiency and security.
JPMorgan Chase Bank, N.A. Member FDIC. Visit jpmorgan.com/commercial-banking/legal-disclaimer for disclosures and disclaimers related to this content.
