Commercial Real Estate Investing: Debt-Service Coverage Ratio – Provides Key to Cash Flow

Cash is King!  To determine ‘cash flow’, the Debt-Service Coverage Ratio (DSCR) gives you the information you need to let you know if you have a workable deal for commercial real estate investing. It is essential to know the Debt-Service Coverage Ratio when applying for a commercial loan.  Find out why…

The Debt-Service Coverage Ratio (DSCR) is a ratio used to analyze the amount of debt that can be supported by the cash flow generated from the property. Cash flow is the name of the game in any investing venture!  Cash is King!  Simply put, it is the net income (Net operating income - NOI) generated by the property divided by the new annual commercial mortgage payment (Debt Service).  Good numbers will provide the insights you need in determining if any deal works, and definitely are essential when presenting to a lender for a commercial mortgage.

Every commercial loan underwriter uses this important factor to determine the approvability of a commercial mortgage requested.  These well worked numbers, on your part, will be expected when seeking a commercial loan.  Don’t leave home without them.

Example:

$100,000 (NOI) / $65,000 (Debt Service) = 1.538 (DSCR)

So... a DSCR of .9 indicates a negative income, and quickly sends up red flags as to the viability of the deal.  This means that there is only enough income available after paying operating expenses to pay 90% of the annual debt service, let alone leave a cash flow profit.  This scenario would not be approved by any lending institution, nor would you want to approach them with a negative DSCR.

Now if a property has a DSCR of 1.25, it is generating 1.25 times as much annual income as the annual debt service on the property; no red flags on this.  This means that this property is generating 25% more income (NOI) than is required to cover the annual debt service.  Commercial loan underwriters are definitely looking for this kind of a scenario before approving a commercial loan.

Regardless of what is going on in the market, prudent investors always avoid being over leveraged with debt. It is a given that the goal is to always buy right which requires presenting lenders numbers that work; this is why in most of our projects we raise more equity through private investors. By doing so, it enables us to create a margin of safety, a consideration for any investing venture. We have also found that the more equity, the more competitive we can be in the market with our rental rates. Having competitive rental rates can be an advantage in filling and getting properties filled for the long term.  More equity helps us to increase our occupancy rates when every other leveraged competitor can’t afford to match our rates. Understanding the DSCR can save you headaches down the road, and help you create the cash flow you are seeking.



Mr. Melero is a principal in the Tampa, FL based HIS Real Estate Network, LLC, a residential real estate and commercial acquisitions and marketing firm where he spearheads income producing real estate projects and oversees the company’s performance. He is a professional real estate investor, speaker, published author and one of the elite mentors of the Trump Institute. Through some of the nation’s leading seminar companies he has sold over 250 residential wholesale properties. He is a dynamic and well-received presenter and has shared the platform with well-known real-estate trainers throughout the United States. Rick is also one of the Managing Members of the Real Deal Community, sponsored by HIS Real Estate Network, one of the fastest growing investor communities with over 20,000 active investors and counting. They have been featured in Forbes, Yahoo Finance, Los Angeles Times and Market Watch. 
 

Article Tags: Debt-service Coverage Ratio, Real Estate, Debt-service Coverage, Coverage Ratio, Cash Flow, Annual Debt

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