Commercial Property Investment & DSCR

Commercial Property Investment & DSCR – When we help our clients find income producing properties to purchase, we are often asked about the loan amount needed and equity down. We refer to them to bankers for specifics but also give them a quick and easy formula for determining an approximate size of the loan.
 
The Debt Service Coverage Ratio (DSCR) is a key metric used by lenders. Just as the Loan To Value (LTV) ratio provides a collateral cushion, lenders require an ability to service cushion. This service cushion is determined by the debt service coverage ratio (DSCR) which is Net Operating Income (NOI) divided by Debt Service. Many banks will require a cushion between 10% and  20% between the NOI and annual debt service (ADS).  For example, if given the first year’s NOI of $125,000 and the DSCR of 1.20, the maximum annual debt service the property can support is $104,166. This amount, $104,166 is now used to calculate the maximum loan amount. Assuming an interest rate of 7.8%,and amortization period of 30 years, the loan would be $1,200,000 which equals an annual  debt service coverage of $104,000. 
 
If you are purchasing a commercial property as an investment and need financing from a bank, you will want to fully understand the various financial metrics a lender uses in determining the maximum loan amount they would be willing to approve.