by John Matheson

DSCR: The Role It Plays In The Commercial Loan Process

The Debt Service Coverage Ratio, also known as "DSCR," and sometimes "DCR," plays a crucial role in the commercial lending space, specifically when lenders are determining the maximum loan amount. In this article, we'll talk about the role of debt service coverage ratio in commercial financing and why it's important.

What is DSCR?

DSCR is the cash flow available to pay current debt obligations. It is used to measure an entity's ability to produce enough money to cover the amount owed.

Why is DSCR important?

DSCR is one of many things that lenders take into consideration when considering a loan application. This ratio is an important metric to lenders because it gives the lender a good indication of whether or not you'll be able to pay the loan back.

The Role Of DSCR In Commercial Lending

Commercial underwriters are very specific in their terms and often pay close attention to metrics such as DSCR to help determine the viability of a borrower. The larger the loan you're applying for, and the longer the term, the more emphasis lenders will put on DSCR. It makes sense if you think about it. Short-term lenders get their cash back more quickly, so they tend to rely more on credit history and monthly revenues.

DSCR In Property Financing

For commercial property, the DCSR is simply the percentage amount of a property's net operating income ( NOI) that exceeds the property's loan payments of principal and interest. This computation can be done annually or broken down monthly.

DSCR In Business Financing

For business credit and corporate financing purposes, knowing the debt service coverage ratio of a business is a handy conversation starter. Don't forget, the measurement of cash flow available that is more than current debt obligations is top of mind for lenders.

If you are going specifically for an SBA loan, they require a DSCR over 1.15 for SBA 7(a) loans of more than $350k.

How To Calculate DSCR

To begin determining your DSCR, you have to gauge the NOI, also known as the Net Operating Income. The net operating income is the result of the equation of revenue minus expenses. You can calculate the ratio on an annual or monthly basis, but yearly usually makes the most sense.

To arrive at NOI for lender underwriting, specific "carve-outs" or lender-required expense allocations must be included in the calculation such as:

  • Market expenses
  • Potential vacancy
  • Tenant improvement and leasing commissions

Fo simplicity reasons, here is the basic DSCR formula to use as a starting point.

Debt Service Coverage Formula = Net Operating Income / Annual Debt Service

FAQs on DSCR

There are a plethora of questions surrounding DSCR. Here are just a few of the most popular.

Do DSCR requirements vary?

Yes, there is somewhat of a scale for DSCR depending on the asset class. Here are a few popular asset classes along with the DSCR that lenders typically keep an eye out for:

  • Multifamily: 1.20
  • Office: 1.25
  • Retail: 1.25
  • Industrial: 1.25
  • Self Storage: 1.40
  • Hospitality: 1.40
  • Business Properties: 1.40
  • Assisted Living: 1.50

What is a good DSCR?

Most lenders expect a DSCR ratio of 1.15 or higher, but requirements vary among lenders and industries.

Are you lender-Ready?

Whether you're applying for a loan right now or not, you'll be a step ahead if you calculate your DSCR on a monthly or annual basis. Again, lenders can calculate the debt service coverage ratio in a variety of ways. To make it simpler for business owners and property investors, Leverage offers finance calculators that automatically calculate DSCR. Plus, the software provides a personalized " lender-ready" report and a way to connect with lenders in the software immediately.

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