DSCR or Debt Service Coverage Ratio is one of the leading metrics used to assess the viability of a loan for an income-generating property.
It measures a borrower’s ability to repay a loan by comparing their income to their debt obligations, usually over a period of 12 months.
DSCR is most commonly used for commercial property loans and multi-family dwellings.
However, it is also a valuable tool for hard money lenders when calculating the risk of financing property flippers and developers.
Here’s how it is calculated and how it applies to flippers and real estate developers in California.
The DSCR formula
The DSCR formula is a simple quotient.
It divides the income a property generates by the total of the loan’s debt repayments.
Hence, it can be written as:
Debt Service Coverage Ratio (DSCR) = Net Operating Income (NOI) / Total Debt Service
The NOI includes all the income the property generates from rent or projected sales before debt payments.
The Total Debt Service is the sum of all principal and interest payments, fees and charges.
In the case of a rental property that charges $600/week, the NOI would be $31,200.
If the debt service or interest payments amount to $475/week or $24,700, the DSCR would be $31,200/$24,700 or 1.26.
This figure is slightly higher than 1.25 which is considered a fair return for a rental or commercial property.
Understanding the DSCR value
The DSCR value or quotient will ideally be above 1.
This indicates that the the property is generating more income than the loan is costing.
If the precise value is equal to 1, the property is generating income equal to the cost of the loan.
If the value is below 1, then the property is projected to lose money.
In this instance, lenders will be extremely unlikely to facilitate a loan.
Minimum requirements for DSCR values typically differ depending on the type of property.
As a guide, these may be:
1.50 Assisted living properties
1.40 Hotels
1.40 Self-storage facilities
1.25 Multi-family living
1.25 Offices
1.25 Industrial properties
How hard money lenders use DSCR
Hard money lenders often loan money to flippers and developers when traditional lenders would not.
They are as concerned with the profit margin of a redeveloped property as they are in a borrower’s ability to meet monthly interest payments.
They use different metrics, based largely on the property’s ARV (After Repair Value) rather than the lender’s credit history.
And so it stands to reason that hard money lenders calculate the DSCR differently to traditional lenders.
Hard money lenders take a forward-looking approach.
They still generally require a DSCR above 1.25 to feel confident that the project will generate enough money to pay off the loan, while also factoring in a safety net.
But some hard money lenders may even green light projects below that level if the lender has sufficient equity or if the ARV is strong enough.
For Flippers
Hard money lenders base the DSCR on the property’s ARV or projected sale price.
Hence the NOI will be the expected profit or ARV less the original purchase price, divided by the debt service or:
DSCR = ARV – Purchase price / Total debt service
For Property Developers
DSCR may be based on projected rental income if the property is to be held or refinanced.
Hence the NOI will be the budgeted rental receipts over the debt service or:
DSCR = Expected rental income / Total debt service
Alternatively, as with flippers, it may be based on sale proceeds after development costs and debt if selling after completion.
DSCR loans
DSCR should not be confused with DSCR loans.
Debt Service Coverage Ratio (DSCR) is the ability of a borrower to service their loan debt, expressed as a quotient.
A DSCR loan, also known as an Investor Cash Flow loan, is a type of loan offered to real estate investors based on their property cash flow rather than personal income.
Get advice today
DSCR is an important metric hard money lenders use when assessing a borrower’s ability to service debt.
But it is just one piece of the puzzle.
Lenders also place great importance on the LTV (loan-to-value).
They consider the experience of the flipper or developer, the relationship they have with them, the amount of equity they have in the property and their exit strategy.
Even the best house flips and developments are doomed to failure without a successful exit strategy.
Whether you are accomplished in the game or just starting out, it’s vitally important to have an experienced and trusted mentor in your corner.
In California, Equidy is all that and more.
Equidy has an intimate and personal history with property in California and has covered all aspects of real estate and property development in the state for more than 40 years.
They work creatively with their clients every step of the way, providing their wealth of knowledge and support network as their projects take shape.
They also help their clients meet all the necessary benchmarks, including DSCR, to qualify for a hard money loan.
Best of all, Equidy doubles as that hard money lender, meaning you can acquire expert advice and gain instant funding for your project in one hit.
They stand by their core belief that anything is possible and they are determined to prove it each and every day.
Even in challenging economic times, they strive to reward entrepreneurship and love to see their clients realize their wealth creation dreams.
Equidy enjoys long and established relationships with serious investors, sellers and real estate professionals while leveraging their reputation and trust, using clear communication to minimise the risk to all parties.
Contact Equidy today to book your free strategy call.
