Definition
Debt Service Coverage Ratio (DSCR) is a financial metric used in real estate to measure a property’s (or borrower’s) ability to generate enough operating cash flow to cover annual debt obligations (principal and interest). In plain terms, it shows whether a property's income is sufficient to pay its mortgage and other debt service.
Formula
DSCR = Net Operating Income (NOI) ÷ Total Debt Service
Where Net Operating Income (NOI) is property income minus operating expenses, and Total Debt Service is the annual principal and interest required by the loan.
How to read DSCR
- DSCR > 1.00: The property generates more income than needed to cover debt payments (positive coverage).
- DSCR = 1.00: Income equals debt payments — no margin for error.
- DSCR < 1.00: Income is insufficient to cover debt — signals risk of default unless other cash sources exist.
Common lender standards
Lenders use DSCR to underwrite loans and set maximum loan sizes. For commercial and investment real estate, most lenders require a minimum DSCR around 1.20–1.25 to provide a safety cushion. Property types with volatile income (hotels, assisted living) often require higher DSCRs (around 1.40–1.50), while stable multifamily assets commonly require ratios near 1.20.
Real-world examples
- A property with NOI = $1,800,000 and annual debt service = $1,400,000: DSCR = 1.29. This typically satisfies lender requirements.
- A property with NOI = $1,000,000 and debt service = $900,000: DSCR = 1.11. Positive but marginal — lenders may view it as higher risk.
- Rental example (monthly): rent = $1,000, mortgage (PITIA) = $1,200 → DSCR = 0.83. Rent does not cover debt.
Why DSCR matters
- Underwriting: Determines whether a loan will be approved and how large the loan can be.
- Loan covenants: Many loan agreements require maintaining a minimum DSCR (e.g., 1.25); failure can trigger penalties, required principal paydowns, or default.
- Risk assessment: Reflects the borrower’s ability to service debt from property cash flow rather than personal funds.
How to improve DSCR
- Increase NOI: Raise rents, reduce vacancies, add revenue streams, or cut operating expenses.
- Refinance: Secure a lower interest rate or extend amortization to reduce annual debt service.
- Increase equity: Bigger down payment lowers loan size and debt service.
- Cost control: Improve management to lower operating costs without sacrificing revenue.
Limitations to keep in mind
- Snapshot metric: DSCR is typically based on current or projected NOI and may not reflect future volatility or capital expenditures.
- Varies by underwriting: Lenders may adjust NOI (add-backs, reserves) or calculate debt service differently.
- Doesn’t include reserves or working capital: A healthy DSCR can still mask liquidity problems if reserves, repairs, or capital projects are neglected.
Quick summary
- DSCR = NOI ÷ Total Debt Service.
- A DSCR > 1 means income covers debt; lenders usually want ~1.20–1.25 or higher depending on risk.
- Used to size loans, set covenants, and assess default risk.
- Can be improved by boosting NOI, lowering debt service, or increasing equity.
