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Understanding Debt Service Coverage Ratio (DSCR)

Understanding Debt Service Coverage Ratio (DSCR)

DSCR = NOI/Total Debt Service

A common misunderstanding made by borrowers when researching and applying for a commercial mortgage loan is how they calculate Net Operating Income (NOI).  Many borrowers do not realize that commercial lenders use actual expenses plus anticipated holdbacks (i.e. vacancy rate, repairs and maintenance, management, etc.)  Holdbacks can also be thought of as unexpected or anticipated future expenses.

What many commercial mortgage borrowers forget, and the commercial mortgage underwriter does not, is that the expenses and holdbacks are a necessary factor should the property go into default.  These are expenses and possible costs that will effect not only how the loan is repaid; but, how the property will be managed should the property come back to the lender through default.

Calculating the Debt Service Coverage Ratio – DSCR –

Let’s use a basic example of how a commercial mortgage lender is going to calculate DSCR using the holdbacks.  The holdbacks in this example are in italics, while these are not direct expenses that are paid out, they are deducted from the Gross Income.

Gross Rent 1,000,000
Other income 0
Annual Gross Income 1,000,000
Less 5% Vacancy 50,000
Effective Gross Income 950,000
Property Taxes 10,000
Maintenance 2,000
Insurance 2,000
Utilities 2,000
Janitorial Service 2,000
Less 5% Mgt Reserve 50,000
Total Operating Expenses 68,000
Effective Gross Income 950,000
Less Total Operating Expenses 68,000
Net Operation Income (NOI) 882,000

Now that you have the Net Operating Income (NOI), then you need to determine the Debt Service. Debt Service is simply the amount of the commercial mortgage loan payment in P&I (principle and interest) only. As you can see from the example above the taxes and insurance are included when determining the NOI.

Example of Debt Service
Commercial Mortgage Loan: $5,000,000 First Mortgage
Interest Rate: 5.5%
Term: 30 Years
Monthly P&I Payment: $28,389
Debt Service (Annual Payments) = $340,673

Now we have all the parts of the puzzle, let’s calculate the Debt Service Coverage Ratio (DSCR):


DSCR = $882,000 / 340,673

DSCR = 2.58%

So what does this all mean? In this case, this shows a commercial mortgage underwriter and lender that the cash flow generated by the property covers the new commercial laon payment by 2.59x.

Now as you look at this example, if the DSCR is 1.0 then you can presume the property generates enough revenue to break even. If the number is negative (i.e. -1.2) then that will alert the commercial lender to a net operating loss.

Contact Senior Commercial Capital to discuss the commercial mortgage process and the available commercial lending packages available for purchases, refinance, construction and more. Click here to contact an Account Executive, today.


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