The Debt Coverage Ratio is also known as Debt Service Coverage Ratio
or DSCR. The debt coverage
ratio or DCR is a widely used benchmark which measures an income producing
property's ability to cover the monthly mortgage payments. The DCR is
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 DCR
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 creates 25%more income (NOI) than is required to cover the annual debt service.
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
Debt
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 the debt
coverage ratio value, the more income there is available to
cover the debt service and thus the less the risk.
Net Operating
Income or NOI is calculated as follows.
Income
Gross Rents Possible
35,000
Other
Income 2,000
Total Gross
Income 37,000
Less Vacancy
Amount 3,000
Gross Operating
Income 34,000
Less Operating Expenses 10,000
Net Operating
Income 24,000
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 coverage ratio must
usually be greater than 1.1 and most lenders require a debt service
coverage ratio greater than 1.2. For this reason, the On
Target software includes the debt service coverage ratio for your
first year of operation on the Executive Summary. The
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
$97.95, click on Purchase
Software
You can learn more about On Target by clicking on the following link.
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