One sentence: DSCR measures whether a property's cash flow covers its debt payments.
If a property generates $125,000 in net operating income and the annual debt payment is $100,000, DSCR is 1.25x. For every dollar of debt service, there is $1.25 of income backing it up.
Here is what it tells you:
--> How much cushion exists before a property cannot pay its mortgage
--> How a lender is pricing risk on the deal
--> How much room there is to absorb a rent dip, a vacancy, or a rate reset
Here is what it does not tell you:
--> Whether the underlying NOI assumptions are realistic
--> Anything about your equity returns
--> Lenders typically want to see 1.20x to 1.25x minimum before they will underwrite a loan. Below 1.0x, the property is not covering its own debt
payments. That is technical default territory, regardless of how good the equity story sounds.
At Westlake, we underwrite conservatively above lender minimums, not to the minimum. We want a DSCR that survives a rate reset or a soft leasing quarter, not one that only works if every assumption holds. That is the whole idea behind neutral to slightly positive leverage: cash flow that works even when rates do not move in our favor.
DSCR will not tell you if a deal is a good investment. It will tell you how much room for error is built into the debt.
What is the first ratio you check before you evaluate a deal?
Wednesday Real Estate 101: Debt Service Coverage Ratio (DSCR)
