Debt Service Coverage Ratio (DSCR)
Also called: DSCR, DCR, Debt coverage ratio
The debt service coverage ratio is net operating income divided by total annual debt service, and it measures how many times a property's income covers its loan payments.
DSCR is the primary credit test in commercial real estate lending. A DSCR of 1.25x means the property generates 25% more income than it needs to pay its mortgage, which is the cushion the lender is underwriting to.
Because DSCR is usually the binding constraint on loan size, it often determines proceeds more than loan-to-value does. In a high interest rate environment a lender may be willing to lend 75% of value on paper, yet the DSCR test caps the actual loan well below that, which is what practitioners mean when they say a deal is debt-constrained rather than value-constrained.
DSCR also appears as an ongoing loan covenant. Falling below the covenant level during the hold can trigger a cash flow sweep or, in severe cases, a default, even when payments are being made.
How to calculate debt service coverage ratio
DSCR = Net Operating Income / Annual Debt Service- Annual Debt Service:
- Total principal and interest paid over twelve months
Worked example
A property with a fixed rate agency loan:
- Net operating income
- $390,000
- Annual debt service
- $300,000
- Calculation
- $390,000 / $300,000
Rules of thumb
- Agency lenders commonly require a minimum 1.25x DSCR on stabilized multifamily. Bridge and construction lenders test a stabilized or forward DSCR instead.
- A DSCR below 1.0x means the property cannot pay its own debt out of operations and requires an interest reserve or an equity infusion.
- Lenders size DSCR on their own underwritten net operating income, not the seller's. Expect them to add a management fee and replacement reserves you may have excluded.
Calculate debt service coverage ratio
Related terms
- Net Operating Income (NOI)
Net operating income is a property's effective gross income minus all operating expenses, excluding debt service, capital expenditures, depreciation, and income taxes.
- Debt Yield
Debt yield is net operating income divided by the total loan amount, measuring the unlevered return a lender would earn if it foreclosed and took the property back on day one.
- Loan-to-Value (LTV)
Loan-to-value is the loan amount divided by the appraised value or purchase price of a property, expressed as a percentage, and it measures how much of the capital stack is debt.
- Interest-Only Period
An interest-only period is a stretch at the start of a loan term during which the borrower pays only accrued interest and no principal, lowering debt service and raising early cash flow.