DSCR Essentials: Enhancing Your Understanding for Real Estate Success

Recently, I have been reading Crushing It in Apartments and Commercial Real Estate by Brian Murry. This book is about how normal small investors can make purchases within the real estate space that is typically thought out to be only for the large players. I am about a third of the way through and there have been some new metrics that I had that much exposure to. One of these metrics is DSCR. I had heard of DSCR loans before but only had a small understanding of what the qualifications were specifically for the loan and what the service provided. DSCR is actually a pretty neat metric and in this post, I am going to cover its definition and how it can be useful when looking at larger income producing assets.

Definition

DSCR stands for debt service coverage ratio. Its formula is as follows:

DSCR = NOI/Mortgage Payments

NOI is calculated by taking your annual income minus your annual expenses (without mortgage payments and expenses for Cap Ex). Your NOI should be positive.

This proportion represents the amount of annual net operating income you'll produce compared to your overall mortgage payments.

Banks typically look at this metric to see how much of a cushion you will have to make payments in the case of changes in your income. The higher the number the more willing a bank is to lend to you because your property is likely performing better. Banks typically require a DSCR between 1.2 and 1.25 at a minimum. A DSCR of 1.0 means that a property is breaking even and anything lower means that the property is losing money.

Having a higher DSCR is crucial for the property’s success. If one major tenant leaves, this will cause a drop in the DSCR and could potentially put you as the investor in a bad place. To avoid this it is important to spread out your income between many tenants. You will want your income coming from multiple sources avoiding concentration and dependence on one or two major tenants. This decreases your risk and ultimately opens the door for a stronger investment in the long run.

Understanding this metric will improve your odds of success as an apartment building investor. Get accurate numbers and make sound judgment calls. The life of your real estate business depends on it. You’ve got this!