Debt Service Coverage Ratio (and what it means for your investment property)
Debt Service Coverage Ratio (DSCR) is a simple way of measuring the ability of an investment property to pay all its operating expenses and any debt that may be against the property. When leveraging your investment property with a Non Recourse Loan it is important to know if the property is capable of covering all its expenses from the rental income produced. This is measured by taking the gross rental income minus all typical operating expenses such as taxes, insurance, vacancy (we use 7% annually) maintenance, utilities, HOA fees, and management costs. The figure left after subtracting these operating expenses from the income produced is called Net Operating Income. The Net Operating Income or NOI is then divided by the principal and interest payments and that equation is a ratio of the NOI divided by the Principal and Interest.
An example would be if a property produced $15,000 in gross rental income for the year, minus operating expenses of $6500 with an $85,000 non recourse loan on it. That would result in a Net Operating Income or NOI of $8500. ($15000-$6500).
Now taking the NOI of $8500 divided by the debt service of $5888 (payments on an $85,000, 25 year loan at 4.875%) results in a Debt Service Coverage Ratio (DSCR) of 1.44 or explained another way, the NOI is 144% of the debt service.
That figure is a good one in that our bank requires at least a 1.25 DSCR for a property to qualify for a loan. Keep this equation in mind when analyzing any rental property you are considering using leverage to buy or refinance.