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  • Steven Fletcher

What Is DSCR & Why Is It Important?

One important metric operators use to assess the viability of a real estate investment is the Debt Service Coverage Ratio (DSCR).


The DSCR gauges whether the property generates enough income to meet its debt payments comfortably.


It's calculated by dividing the property's net operating income by its total debt service.


Why is it important?


Risk Assessment: (Crucial) DSCR provides insight into the risk associated with a property. A higher ratio indicates that the property generates sufficient income to cover its debt obligations, implying lower risk for lenders and investors. Need to account for downside scenarios here and make sure you’re able to withstand a substantial decrease in rents in the event of a downturn.


Lender Requirement: Lenders use DSCR as a criterion for loan approval. They need ratios above a certain threshold to write the loan and ultimately make sure they won't lose their shirt.


Decision-Making: For investors, DSCR is a variable in determining the profitability and stability of an investment. Higher ratios indicate you have a better ability to take on pain.


Things to consider:


Thresholds: Ideal ratios vary based on location, property type, and market conditions- a ratio of 1.25 or higher is generally considered favorable for multifamily properties.


Underwriting Standards: Lenders have specific criteria and will analyze the property’s income sources, vacancy rates, operating expenses, etc. Need to have tight, conservative underwriting and familiarize yourself with their process.


Operational Efficiency: Improving DSCR doesn't always mean increasing rental income. Tightening expenses will improve this number- shop out your insurance policies, preventative maintenance, not planting sod, etc.


The DSCR ratio informs portions of your due-diligence process, helps assess downside risk, and sheds light on the performance of the asset.

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