The DSCR and Commercial Mortgages

Article by Joe Bartolotta, a Florida Upfront Mortgage Broker with Fidelity Mortgage Services

How does an investor know if they are purchasing a property that will give a positive cash flow? How does a lender know if the property is a wise investment for them to lend on? While there are numerous factors used to answer both questions above, one answer that is used by both is the Debt Service Coverage Ratio formula. I am sure most people do not know what a dscr is, by reading this post, I will explain how to calculate it and if the property you are interested in is a wise investment.

Debt Service Coverage Ratio

What is it?

Definition:
The debt service coverage ratio, or debt service ratio, is the ratio of net operating income to debt payments on a piece of investment real estate. The higher this ratio is, the easier it is to borrow money for the property. The phrase is also used in corporate finance and may be expressed as a minimum ratio that is acceptable to a lender…

Here’s what you need to know:
Divide your Net Operating Income (NOI) by the Total Annual Debt Service or simply stated, divide your income over your mortgage payments for the year.

Note -- Net Operating Income on a property can have numerous variables depending on the property type. If you are purchasing a commercial NNN (triple net) property, then the tenant pays for all expenses, the Net Operating Income would be the total rent.

In commercial real estate, lenders on owner occupied properties usually require a 1.0 dscr, but have been known to go down to .90 dscr. This means that the property is actually covering only 90% of the debt. On the other hand, investment properties usually require a higher dscr, the range is typically from 1.2 to 1.5, the use of the property will be a main factor in determining the dscr required. For example, an A+ office building will have less risk associated with it and therefore would have a lower dscr while a property that can be used for a single purpose would have a higher risk and correspondingly a higher dscr requirement.

In summary, I hope I have given you an easy way to help decide if a property is a good investment relative to its cash flow.
If the DSCR is less than 1 - negative cash flow - most likely a bad investment
If the DSCR is equal to 1 - you have neither gains nor losses - you breakeven
If DSCR is greater then 1 - then you have a positive cash flow.

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Joe Bartolotta is a Mortgage Consultant with Fidelity Mortgage Services in Altamonte Springs, Fl. I am honored to be a charter member of the Upfront Mortgage Brokers Association. I offer a Lender Fee Guarantee, what I disclose in the beginning is what I deliver in the end. Contact me for more details.