Step One: Determine the Gross Operating Income (GOI)

The first step in calculating the DSCR is to determine the property’s Gross Operating Income (GOI). The GOI is the income generated by the property before accounting for any expenses like property taxes, repairs and maintenance, and vacancy rates. To calculate GOI, you need to add up all the rents and other income streams the property generates within a given timeframe (usually annually).

Step Two: Calculate the Operating Expenses

After determining the GOI, you need to calculate the Operating Expenses. Operating expenses are all the costs associated with running the property, including property taxes, insurance, maintenance fees, and management expenses. These expenses are subtracted from the GOI to determine the Net Operating Income (NOI).

Step Three: Determine the Interest and Principal Payments

Now that you know the NOI, you can determine the interest and principal payments necessary to finance the property. These payments are based on the loan’s terms, including the interest rate and the number of years required to repay the loan fully.

Step Four: Divide the NOI by Interest and Principal Payments

After determining both the NOI and the interest and principal payments, you can calculate the property’s DSCR by dividing the NOI by the total interest and principal payments. A DSCR of at least 1.0 means that the property generates enough income to cover its expenses fully. A DSCR of less than 1.0 indicates that the property does not generate enough income to cover its debt obligations.

Step Five: Analyze the DSCR for Investment Opportunities

Once you know how to calculate DSCR, you can use the DSCR to determine whether an investment opportunity is feasible. A high DSCR means that the property generates enough income to cover its obligations, which is attractive from an investment standpoint. A low DSCR may signal that the property requires significant financial injections to maintain its stability.

What is DSCR, and why is it important?

The Debt Service Coverage Ratio (DSCR) is a measure of a property’s cash flow availability, and it’s a critical metric for lenders when assessing the risk of financing an investment property. DSCR indicates if a property has sufficient net operating income (NOI) to cover its mortgage payment and operating expenses. Essentially, this ratio measures the number of times a property generates sufficient cash flow to meet its debt obligations. DSCR is a critical metric for investors in determining the financial health of the property.

How do you calculate DSCR?

Calculating DSCR is a simple and straightforward mathematical exercise. The formula used to calculate it is as follows:

DSCR = Net Operating Income (NOI) / Total Debt Service

Net Operating Income includes all income generated from the property, such as rent, less any operating expenses, such as taxes, insurance, and utilities. Total Debt Service is the total of all debt-related monthly payments, including principal and interest payments, on any loans used to finance the property.

So, for example, if your property’s NOI is $100,000 per year, and your total Debt Service (principal and interest) is $80,000 per year. Simply divide NOI by Total Debt Service, giving you a DSCR of 1.25.

What is an ideal DSCR?

The lower the DSCR, the higher the risk of default, which makes it more difficult to secure financing. A DSCR of 1.0 is break-even – that means that the revenue generated matches the debt obligation.  In an ideal world, you want a DSCR above 1.25, indicating that your property generates 25% more cash flow than it needs to cover its debt obligations. For commercial or multi-unit properties, lenders typically require minimum DSCRs of 1.2 to 1.35. Hence, based on the investment property, determine a DSCR that assists to generate solid income while meeting financing requirements.

How to increase your DSCR? There are two ways to increase your DSCR.

Increase Net Operating Income – This involves increasing rental income and/or decreasing operating expenses to increase cash flow from the property. For example, if your property has a current NOI of $100,000 per year, you could increase it to $120,000 by raising rents or reducing expenses to realize a higher DSCR.

Refinance to lower your monthly debt service – Refinancing is used to lower your monthly mortgage payment, bringing down your total debt service. By doing so, you can experience the leverage and strengthen your financial status. This helps to obtain better interest rates and terms; refinance might increase your DSCR based on the property’s income.

In summary, knowing how to calculate DSCR is essential for any real estate investor looking to make profitable investments. It is a simple yet crucial formula that provides a snapshot of the property’s financial stability. By determining the Gross Operating Income, Operating Expenses, Interest and Principal payments, and dividing NOI by Interest and Principal Payments, you can quickly calculate the debt service coverage ratio of any investment property. This knowledge will help you make informed financial decisions and invest in properties that generate a profit in the long run. So go ahead and use this simple formula to evaluate your next investment opportunity. If you are in the market for a DSCR loan 30 Year Rental loan check out our program. 

In conclusion, when investing in an investment property, calculating the DSCR is a critical financial analysis that helps in your decision-making process. Therefore, it’s crucial to understand the formula of calculating DSCR to avoid any surprises. The calculation is simple, and by calculating DSCR, you can determine the property’s financial health. Remember, maintaining a high DSCR is a sign that the property generates enough cash flow to meet its debt obligations, making it an attractive proposition for creditors, financiers, and investors. Use and apply this knowledge to make smart decisions, remove risk, and achieve good returns on your properties.