The debt coverage ratio or DCR is also known as
debt service coverage ratio. The debt coverage
ratio is a widely used benchmark which measures an income producing
property's ability to cover the monthly mortgage payments. The
calculated by dividing the net operating income (NOI) by a property's
annual debt service. Annual debt service equals the annual
total of all interest and principal paid for all loans on a
property. A debt coverage ratio of less than 1 indicates that
the income generated by a property is insufficient to cover the
mortgage payments and operating expenses. For example, a
debt coverage ratio
of .9 indicates a negative income. There is only enough
income available after paying operating expenses to pay 90% of the
annual mortgage payments or debt service. A property with a DCR
of 1.25 generates 1.25 times as much annual income as the annual
debt service on the property. In this example, the
property produces 25% more net operating income than is required to pay the annual debt service
and operating expenses.
Example: We are considering buying an investment property with a
net operating income of $24,000 and annual debt service of $20,000.
The DCR for this property would be equal to 1.2. This means that
it generates 20% more annual net operating income than is required to cover
the annual mortgage payment amount.
Net Operating Income $24,000
Coverage Ratio = ----------------------------- =
----------- = 1.2
Annual Debt Service $20,000
Many lending institutions require a minimum debt coverage ratio value
to procure a loan for income producing properties. DCR
requirements for lending institutions may vary from as low as 1.1 to as high as 1.35.
From a lending institutions perspective, the higher it is, the more income there is available to
cover the mortage payments and thus the less the risk.
Income or NOI is calculated as follows.
Gross Rents Possible
Less Operating Expenses 10,000
Operating Expenses include the following items; advertising,
insurance, maintenance, property taxes, property management,
repairs, supplies, etc.
Lenders use the debt coverage ratio to
determine if an income producing property has sufficient income to
cover the operating expenses and debt service. To acquire a
loan for an income producing property, the debt service coverage ratio must
usually be greater than 1.1 and most lenders require a DCR ratio greater than 1.2. For this reason, the On
Target software includes this important ratio in the Executive Summary
Executive Summary summarizes the most important data from all of the
other On Target reports. To purchase the On Target real estate
investment analysis software for
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