Commercial Mortgage Quick Reference Guide
Debt Coverage Ratio (DCR)
Debt Coverage Ratio, or DCR, also known as Debt Service Coverage Ratio (DSCR), is a metric that looks at a property’s income compared to its debt obligations. Properties with a DSCR of more than 1 are considered profitable, while those with a DSCR of less than one are losing money.
How Debt Coverage Ratio Relates to Multifamily Loans Commercial Real Estate Financing
Along with LTV/LTC, DCR/DSCR is an essential part of the decision-making process when a commercial or multifamily lender decides whether to issue a loan. In general, if a property has an abnormally low DCR/DSCR, they will have difficulty paying back their loan on time. This is why the majority of lenders like borrowers to have DSCRs of at least 1.15- 1.25x. In general, properties with lower LTVs may be able to qualify for funding with lower DCRs/DSCRs. In addition, ‘safer’ property types can also qualify for loans with lower DCRs. For example, while risky property types such as hotels or motels might need a 1.30-1.50x DSCR to get funding, traditional multifamily or commercial properties (think apartment buildings or shopping centers with an anchor tenant) would only need around 1.20x.
The DCR/DSCR formula is: Net Operating Income (NOI)/Debt Obligations. Despite the apparent simplicity of the formula, an investor will need to make sure they have the correct numbers in order to calculate an accurate debt coverage ratio for a property.
For instance, Net Operating Income/NOI is typically calculated using EBDITA. This means that you should not deduct taxes, interest, or other costs from your NOI calculation before entering it into the DCR formula. Now, let’s look at the debt coverage ratio formula in action. Let’s say that a multifamily property had a NOI of $2,000,000, and annual debt obligations of $1,650,000. In that case, it would have a DCR/DSCR of:
$2,000,000/$1,650,000 = 1.21x DCR/DSCR
What is Global DCR?
Global DCR is when a DCR/DSCR formula factors in a borrower’s personal income and personal debts into the equation. This is typically only done in the case of small business owners, as well as small multifamily and commercial real estate investors, as lenders want additional reassurance that these individuals are financially responsible and likely to pay back their debts on time. If a borrower has a high income and little personal debt, using global DCR will benefit them, while if they have lower income and higher personal debts, it will make it more difficult for them to obtain commercial or multifamily real estate financing.
Business DCR vs. Property DCR
For CMBS, life company, HUD multifamily, and other asset-based multifamily loans, the property itself is of foremost importance (though HUD multifamily and Freddie Mac/Fannie Mae do take a close look at borrower financials). However, if you own a small business and would like to use an SBA loan, like the SBA 7(a) or SBA 504 loan, the actual DCR/DSCR of your business will be of importance as well.
For instance, the SBA requires that 7(a) borrowers have a business DSCR of no less than 1.15x in order to qualify for funding. Keep in mind that your DCR/DSCR for a loan calculates not just your current debts, but the annual debt obligation that you will be taking on as a result of your new loan. Also, as mentioned earlier, you will want to use earnings before interest, tax, depreciation and amortization (EBITDA) when you plug your business’s net operating income into the DCR formula.