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In real estate, the debt service coverage ratio (DSCR) measures a property’s available cash flow to cover its short-term debt obligations. DSCR is an indicator of a property’s financial health, so understanding how the ratio works and its uses is important for rental property investors.
In this article, we’ll explain what DSCR is, how it affects rental property owners, and how to calculate it for your properties. We’ll also discuss ways to improve your ratio and what a DSCR loan is.
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Key Takeaways
- DSCR for real estate measures how well a rental property’s income covers its debt payments and shows financial health.
- Lenders use DSCR to determine loan approval, loan size, and interest rates for rental investments.
- Landlords can improve DSCR by raising rental income, refinancing debt, increasing property value, or reducing expenses.
- Regularly tracking DSCR helps landlords spot financial trends, evaluate new properties, and plan for future growth.
What is DSCR?
The debt service coverage ratio (DSCR) is a metric that assesses a borrower’s ability to cover their minimum debt obligations. It indicates a property’s (or company’s) financial health and answers a key question: How easily can a property’s cash flow cover the debt required?
DSCR measures the percentage of a property’s gross annual income that it needs to cover debts like mortgages or loans. It’s like the debt-to-income ratio, because it shows how much of your income is consumed by debt.
How to Use DSCR in Rental Property
Lenders consider your debt service coverage ratio when you apply for a loan or when you need to refinance. The lender will calculate your DSCR at both the property and portfolio levels when considering your application, and your ratio influences the size and terms of the loan offered.
When DSCR is calculated at the portfolio level, it’s known as a global DSCR. This helps lenders see how you manage income and debt in your rental business, and it enables you to see how adding a new property could affect it. Your global DSCR helps you understand how a change in an adjustable-rate mortgage can impact your portfolio.
If your DSCR is too low, lenders will be hesitant to approve a loan.
Aside from securing favorable loan terms, landlords can use the debt service coverage ratio in other ways:
- Calculate the ratio each month to analyze your average trend and to project future ratios. A declining DSCR can be an early indicator of declining financial health.
- Use the ratio in budgeting and strategic planning.
- Compare the financial health of your portfolio’s properties.
- Evaluate potential investment properties.
How do you calculate DSCR for rental property?
Your debt service coverage ratio equals the net operating income (NOI) divided by the total debt service.
DSCR = net operating income (NOI) ÷ total debt service
Debt service refers to a property’s current debt obligations, like lease payments and the principal and interest on loans. To calculate your total debt service, use this formula:
Total debt service = monthly lease and loan payments × 12
For example, let’s say your property has an annual NOI of $50,000. You pay $2,250 per month for the property’s mortgage and other loans. Your annual debt service is $27,000, and the DSCR is 1.85.
$2,250 × 12 = $27,000 Total debt service
$50,000 ÷ 27,000 = 1.85 DSCR
When you’re calculating your global DSCR, you’ll use your total NOI and your debt service from the entire portfolio.
How to Calculate Net Operating Income for Real Estate
Net operating income is comparable to EBIT, a business’s earnings before interest and taxes. Think of NOI as the profit from your rental’s daily operations. It’s the total income minus total operating expenses.
NOI = total income – total operating expenses
Operating expenses cover costs like utilities, maintenance, and property management software. Just keep in mind that operating expenses don’t include all costs. When totaling your operating costs, exclude these items:
- One-time projects, like replacing a roof.
- Nonoperational costs, like loan payments.
- Taxes or interest payments.
Pro tip: Factor in a set yearly amount to account for capital expenditures as they come up.
The downside of DSCR is that, because it doesn’t account for all expenses, company income may be overstated. Accuracy matters because over- or underestimating your NOI can lead to trouble. An inflated NOI overestimates a property’s ability to generate income and cover a mortgage. But if you underestimate, you may have trouble securing loans or receive worse terms.
Because DSCR depends on your operating costs, your bookkeeping is crucial. Need some help getting your books in order? Start with this guide: “Real Estate Accounting 101: Everything Landlords Must Know.”
Did you know? You can use TurboTenant Accounting’s built-in NOI report to calculate DSCR at the property and portfolio levels.
What’s a good DSCR?
Each lender has different standards for a “good” DSCR, depending on property types and markets. Use this range to evaluate your ratio.
- Less than 1: This means the property doesn’t generate enough NOI to cover principal and interest payments. You’d need to use outside sources to cover debt payments. For example, a DSCR of .85 means the property’s operating income can cover 85% of the annual debt payments.
- Equal to 1: The property’s cash flow exactly covers debt payments. No funds are left for owner income or a cushion. Properties with a DSCR at or below 1 are vulnerable because a minor dip in cash flow might mean the property can’t cover the debts. Vacancies or unbudgeted operating costs put the cash flow at risk.
- Over 1: The property comfortably covers the debt service and has funds left over. This gives you some cushion for vacancies or unplanned costs.
Many lenders set minimum requirements of 1.2 to 1.25 DSCR for loans. There’s no industry standard, but a DSCR of 2 is considered very strong. The higher your DSCR, the better your loan terms will be because your loan is considered less risky.
How can you improve a property’s DSCR?
Your property’s DSCR will change over time as the NOI rises and falls. These four strategies can help you improve DSCR:
- Increase rental income: Adjust the rent rates, reduce tenant turnover, or create an additional income stream at the property.
- Refinance current loans: Reduce your total debt service to lower your debt obligations. Even if your income stays the same, this will increase DSCR.
- Increase property value: Upgrade the property’s kitchen or bathrooms. Expand units with an addition, or add amenities, like in-unit laundry facilities or on-site storage.
- Reduce expenses: Improve energy efficiency to reduce utility costs, focus on proactive maintenance to prevent costly problems, appeal your property taxes, or bundle your insurance policies for discounts.
What is a debt service coverage ratio loan?
A DSCR loan, or an investor cash flow loan, is a mortgage meant for purchasing residential investment properties. DSCR loans are a type of non-qualified mortgage intended for borrowers who don’t meet the criteria for typical mortgages. The flexible qualifying criteria make these loans a good fit for self-employed people, including rental property owners.
With a traditional mortgage, you need to provide information about your personal income and employment. But with a DSCR loan, you can qualify based on an analysis of the rental property and its projected income. This gives you faster, easier access to capital..
The lender uses DSCR to measure the property’s expected cash flow and gauge its ability to cover the loan. Lenders may also require that you meet a specific credit score or pay a down payment.
The drawback of DSCR loans is that they may carry higher interest rates because they involve greater risk. The down payment may also be as high as 25%, depending on your credit score. And since not all lenders offer DSCR loans, finding a loan that you qualify for and that meets your needs may be more difficult.
Common DSCR Loan Requirements
DSCR loan requirements vary by lender, but these criteria are typical:
- $100,000 minimum loan
- $3 million maximum loan
- 20% down payment
- DSCR of 1.0 or higher
- Minimum credit score of 620
Be prepared to share an appraisal report showing the property’s value. Lenders will also consider the property’s loan-to-value ratio, which measures risk and helps determine the down payment needed. Keep in mind that most DSCR loans also come with prepayment penalties — which means if you refinance or pay off the loan early, you’ll have to pay additional fees.
Streamline Your Rental’s Finances with TurboTenant Accounting
Whether you’re applying for a DSCR loan or using the ratio to monitor your rental’s health, you need to track and understand your property’s finances.
That’s where TurboTenant Accounting comes in. Our platform is designed specifically for rental property investors, giving you the accounting tools you need to organize your books and optimize your deductions.
Save Time and Support Daily Rental Operations
We know managing rental property takes time and attention—that’s why TurboTenant Accounting includes features to save you time without sacrificing accuracy in your books.
- Import transactions automatically.
- Integrate your books directly with your bank account.
- Match transactions based on rules.
- Set up your books quickly with our property-based accounting framework and preconfigured chart of accounts.
- Reduce errors by using our rental-specific templates.
- Import payout statements from Airbnb and VRBO.
- Track mileage.
Rely on Reports Specific to Rental Property
TurboTenant Accounting includes accountant-approved financial reports meant for real estate investors. Make smart, informed decisions for your portfolio with our pre-built performance and financial reports, including:
- Profit and loss
- Rent roll
- Cash flow
- Net operating income
- Cash on cash
- Balance sheet
- Operating expense ratio
Even better? With TurboTenant Accounting, you can run reports at the unit, property, or portfolio level. That means you can calculate DSCR and evaluate the health of each part of your business.
Simplify Tax Season Prep
We also include crucial tax-prep features and support to take the hassle out of tax season. TurboTenant Accounting helps you track fixed assets, calculate depreciation, review 1099 thresholds, and find easily missed deductions with our Tax Review.
We’ve even got reports for Schedule E and Form 8825, plus a Tax Packet export, so your data is organized and ready for your tax preparer. And with our accountant access option, your CPA can access your books directly to pull reports on demand.
Accounting Built for Real Estate Pros Like You
Spreadsheets and generic accounting programs are more hassle than they’re worth. We designed TurboTenant Accounting for rental property owners like you. Ready to track your cash flow, download one-click tax packets, and simplify your bookkeeping? Sign up for TurboTenant Accounting today!
Debt Service Coverage Ratio for Real Estate FAQs
What is a good debt service coverage ratio in real estate?
A DSCR above 1.25 is usually considered strong. That means a property’s cash flow will cover its debt obligations and have a little cushion to account for vacancies or unexpected expenses.
How to calculate the debt service coverage ratio for real estate?
Calculate the DSCR by dividing the property’s net operating income by its total debt service, which is the interest and principal payment for loans.
Do DSCR loans require 20% down?
Down payment amounts for DSCR loans vary by lender, but most usually require 20% of the property value. The down payments for DSCR loans depend on multiple factors: the DSCR, the loan amount, your credit score, the size of your cash reserve, and the property’s value and type.
How is DSCR different from DTI?
The debt service coverage ratio and the debt-to-income ratio both represent debt obligations compared to total income. Typically, DTI is used only in real estate, but DSCR is used in both real estate and business.
