Debt Service Coverage Ratio (DSCR) is the measure of a property’s cash flow to service its debt. It is calculated by dividing the Net Operating Income (NOI) by the annual debt service. Here is the formula:
DSCR= NOI/Annual Debt Service
For example, a property generates an NOI of $100,000 annually and its annual debt service is $81,783, so the equation would like this:
DSCR= $100,000/$81,783
DSCR=1.223
This is commonly expressed as 1.22x, meaning the cash flow generated from the property is sufficient or positive and is enough to cover the annual debt service. A DSCR of less than 1.00x means the property cash flow is insufficient and is therefore negative in that it does not generate enough income to cover its annual debt service.
Most lenders have a minimum DSCR which is usually 1.20x or even higher. While DSCR determines the ability of a cash flowing asset to cover its debt, the DSCR can be altered certainly by a change in the interest rate, but more importantly an adjustment to the amortization period. In a separate blog, we will compare DSCR, LTV and Debt Yield.
Related: Understanding Debt Yield and Why It's Important to Lenders, Understanding Capitalization Rate Formula
