Real Estate Investor Financing 101: DSCR (Debt Service Coverage)

[Robin Simon]

From a twitter series:

Along with LTV, one of the most important key metrics lenders look at when determining eligibility, rates and terms for investment property loans. Crucial to understand!

DSCR is simply the ratio of how much revenue the property is earning (through rents on long-term leases, gross receipts from airbnb, etc.) divided by the expenses for the property.

Essentially, it measures whether the property is cash-flowing (making $) or not.

1.00x DSCR = breaking even, or your revenues are equal to your costs every month.

>1.00x DSCR = you are making money, for example if your DSCR is 1.50x, you are making a profit of 50 cents for every dollar of rent. (Example could be Rents are $1,500, Expenses are $1,000)

<1.00x DSCR = you are losing money, so each month you have negative cash flow! (Example could be Rents are $750, Expenses are $1,000, so your DSCR is 750/1000 = 0.75x.

Note - it can sometimes make sense to invest in real estate with a sub-1.00x DSCR!

Key to understanding DSCR is also how your lender will calculate it, which can be different depending on the property/loan program and will certainly be different than how you underwrite the investment yourself!

"DSCR" lenders that lend on 1-4 unit residential properties (known as "DSCR" loans) will calculate DSCR as:

Rents / PITIA

PITIA = principal + interest + taxes + insurance + HOA dues

Note - this does NOT include any other expenses such as utilities, repairs or management fees!

Commercial Real Estate lenders (for properties such as larger multifamily buildings, offices, retail, etc.) also make DSCR a key component of their lending underwriting, however this is typically calculated differently:

Net Operating Income / Debt Service (Principal + Interest)

Make sure you understand how your lender is calculating! In the commercial version of DSCR, many more expenses are considered and the taxes and insurance are netted out of the numerator. There is also likely to be a reduction for vacancy and credit loss (to acct. for turnover)

Finally, while your lender will have their methodology for calculating DSCR to determine cash flow potential, when you underwrite your own deals, its important to both understand the differences and base it on your own situation, risk tolerance and unique advantages.

Bottom Line - An important piece of real estate investing is to understand your cash flow and DSCR is the best metric to evaluate it. Be mindful of how YOU want to calculate/underwrite it as well as knowledgeable as to how your lender will as well.