11/26/2023
What Is The Debt Service Coverage Ratio (DSCR)?
The debt service coverage ratio (DSCR) measures the ability of a borrower to repay its debt. The DSCR is widely used in commercial loan underwriting and is a key formula lenders use to determine the size of a loan.
Debt Service Coverage Ratio (DSCR) Formula
The debt service coverage ratio formula depends on whether a loan is for real estate or a business. While the logic behind the DSCR formula is the same for both, there is a difference in how it is calculated.
DSCR Formula for Real Estate
For commercial real estate, the debt service coverage ratio (DSCR) definition is net operating income divided by total debt service:
For example, suppose Net Operating Income (NOI) is $120,000 per year and total debt service is $100,000 per year. In this case, the debt service coverage ratio (DSCR) would simply be $120,000 / $100,000, which equals 1.20. Itβs also common to see an βxβ after the ratio. In this example, it could be shown as β1.20xβ, which indicates that NOI covers debt service 1.2 times.
Debt Service Coverage Ratio (DSCR) Meaning
What does the debt service coverage ratio mean? A DSCR greater than or equal to 1.0 means there is sufficient cash flow to cover debt service. A DSCR below 1.0 indicates there is not enough cash flow to cover debt service. However, just because a DSCR of 1.0 is sufficient to cover debt service does not mean itβs all thatβs required.
Typically, a lender will require a debt service coverage ratio higher than 1.0x to provide a cushion in case something goes wrong. For example, if a 1.20x debt service coverage ratio was required, then this would create enough of a cushion so that NOI could decline by 16.7%, and it would still be able to fully cover all debt service obligations.
What is a Good Debt Service Coverage Ratio?
What is the minimum or appropriate debt service coverage ratio? Unfortunately, there is no one size fits all answer and the required DSCR will vary by bank, loan type, and by property type.
However, typical DSCR requirements usually range from 1.20x-1.40x. In general, stronger, stabilized properties will fall on the lower end of this range, while riskier properties with shorter term leases or less creditworthy tenants will fall on the higher end of this range.