Real estate investing involves a healthy amount of alphabet soup – tons of industry-specific acronyms for investors to keep track of. Experienced investors are probably very well aware of what DSCR stands for, but even still, we tend to get questions about why this metric is so important. So, in an effort to peel back the curtain a little bit, we decided to write this brief article to take a little bit of a deeper dive on DSCR, what it is, and why it’s important when it comes to investing in real estate.
What is DSCR?
DSCR stands for Debt Service Coverage Ratio, and at its core, it measures the ratio of income generated by a rental property to the amount of debt owed on that property. This is a metric that’s most often used in long-term real estate financing, particularly when it comes to properties that will be held as rental investments. What it measures, strictly speaking, is the ratio of income generated for every dollar owed from the loan.
If this number falls below 1, it means that the property in question is not generating enough income to pay back the loan on its own. Most lenders require a minimum in the range of 1.2-1.5 to qualify for a loan to ensure that, not only can the loan be paid back, but that the borrower is cash flow positive.
How Do You Calculate DSCR?
DSCR is calculated by taking the net operating income generated by a rental property and dividing it by the amount of debt owed on that property. As an example, let’s say you own a duplex with an annual rental income of $38,400, but the payments you make towards debt on that property total $24,000 annually. $38,400/$24,000=1.6; at a DSCR of 1.6, the rental property is not only covering the debt service, but is also generating positive cash flow.
Depending on the length of the loan and your lender’s underwriting process, they may also calculate certain costs including third-party property management, expected vacancy rates, or even the cost of future repairs to help determine what DSCR they’re comfortable with.
Ultimately, there are a lot of factors to consider. At Pimlico Capital, we offer a very transparent process and will communicate effectively with you throughout. It’s why we have unanimously great reviews!
What Can I Do if My DSCR is Too Low for My Desired Loan Amount?
Ultimately, you only have two options if you find that you can’t get approved for a loan because your DSCR is too low. You’ll either have to put the idea on hold, wait out any current leases, and increase rent for the following year, or you’ll have to accept a lower loan amount.
In the right circumstances, it may make sense to wait and increase rent prices, especially if rent in the area has gone up significantly and you’re confident that you’ll be able to lease the properties without risking a lengthy vacancy. For the most part though, the easier path forward would be to accept a lower loan amount. Sometimes that means that the deal might not work.
Where Can I Get a DSCR Loan?
Pimlico Capital offers DSCR loans for rental properties. To find out if you qualify for a DSCR loan, give us a call at 410-855-4600, or get pre-qualified by filling out our online rate calculator! Once we have your info, we’ll get in touch to confirm details and walk through your financing options.
We always keep our clients’ best interests in mind, and have developed many long-lasting relationships as a result. Give us a call today and let’s get started on your next purchase or refinance!