Understanding key financial metrics can be the difference between success and stagnation in real estate investing. One of the most pivotal metrics to understand is “DSCR,” or Debt Service Coverage Ratio. Traditionally, DSCR has been used by financial institutions for decades to gauge a property's financial health. A new spin on DSCR has emerged as a unique loan product. Let’s break down both the traditional ratio and this innovative loan model.
The Traditional Role of DSCR in Real Estate Investing
DSCR stands for Debt Service Coverage Ratio. While "DSCR loan" hasn’t been a standard term, the concept of DSCR has always been crucial in lending, especially in commercial real estate and business loans.
The Debt Service Coverage Ratio (DSCR) is a financial metric that measures the cash flow available to pay current debt obligations. It's calculated as:
DSCR = Net Operating Income/Total Debt Service, where “Net Operating Income” is the annual income generated from a property or business, excluding extraordinary income and expenses, and “Total Debt Service” is the annual total of all principal, interest, and lease payments associated with the debt on a property or business.
In this traditional context, a DSCR of 1 means the property's income exactly covers its debt. A figure above 1 indicates a surplus of income over debt, while a number below 1 suggests potential difficulties in meeting debt obligations, which is a red flag for lenders. As another example, a DSCR of 1.5 means that 50% more income is available than is required to cover the debt.
The DSCR has always been an essential tool at Vintage Real Estate Services. It helps our investor clients:
Evaluate a property's potential before purchasing.
Secure financing, as lenders often look at DSCR to assess risk.
Make informed decisions about rents, refinancing, and portfolio management.
The Evolution: DSCR as a Loan Product
While DSCR as a ratio has been a metric used in real estate investing, there's a recent development in the real estate investing world where "DSCR" has been transformed into a loan product. This might sound confusing initially, especially for those familiar with the traditional use of the term.
For this new DSCR loan product, the formula is distinct from traditional calculations. We spoke to Doug Smith, CEO of Castle Rock Capital Funding, who clued us in on this new loan product:
“DSCR stands for “Debt Service Coverage Ratio,” and the term has been used by banks for decades. It is simply a measure of the cash flow of a property, but the new DSCR loan product calculates DSCR very differently than a commercial bank would. For our purposes, DSCR = Rental Income (Gross) / Loan Principal and Interest + Real Estate Taxes + Property & Flood Insurance + HOA fees. A DSCR of 1.0 or higher (the higher, the better) means a property is positively cash-flowing. We have numerous programs for this type of loan…some require a 1.0, some require more, and some will go down as low as 0.75, but different programs have different guidelines. One thing to remember is that you want to be consistent with the variables you are plugging into the equation. If you are using monthly rent, you need to make sure other variables are monthly. If you go for annual rent, you’ll need to annualize the other variables. If you don’t, you won’t get an accurate number.”
In this innovative approach, a DSCR of 1.0 or more signals positive cash flow for a property. Different loan programs related to this product have varying DSCR requirements. Some might necessitate a DSCR of 1.0 or even higher, while others are flexible enough to consider ratios as low as 0.75. Consistency in the calculation is key. If you're using monthly rent figures, all other variables in the equation should also be monthly. The same rule applies if you use annual data.
Vintage Real Estate Services: Bridging Tradition with Modernity
With its rich legacy in Tampa Bay, Vintage Real Estate Services has witnessed and adapted to many changes in the real estate market. The introduction of the DSCR loan product exemplifies the market's continuous evolution.
While Vintage Real Estate Services doesn’t offer loan products, we keep our clients informed and help them navigate the shifting landscape of real estate investments. Whether utilizing traditional DSCR calculations to evaluate potential investments or understanding the intricacies of new loan products, Vintage Real Estate is committed to empowering its clientele.
Dave Sigler, a visionary leader with extensive experience in the real estate realm, drives the team at Vintage with a forward-thinking approach. By melding the tried-and-tested methods with contemporary strategies, Dave and his team ensure that property owners and investors receive the most up-to-date real estate investing guidance. Contact us today for guidance about investing in Tampa Bay real estate.