The definition and formula
DSCR equals net operating income divided by annual debt service, where debt service is the total of the year’s principal and interest payments. A ratio of 1.0x means the income exactly covers the payments. A ratio of 1.25x means the property earns 25% more than it needs to pay the loan.
Because property taxes, insurance and other operating costs are already subtracted in NOI, the debt service in the ratio is only principal and interest.
A worked example
A building produces $180,000 of NOI. Its $2,000,000 loan at 6.25% on a 30-year amortization costs about $147,800 a year. DSCR is $180,000 ÷ $147,800, or about 1.22x.
If the lender’s minimum is 1.25x, the most annual debt service the building can support is $144,000, which at the same rate and term is a loan of about $1,949,000. The borrower either reduces the loan, adds equity or finds better terms.
What lenders look for
Minimums depend on the lender, the program and the property. Agency lenders on stabilized multifamily often look for around 1.20x to 1.25x, and banks frequently require similar or slightly higher coverage. Bridge lenders financing value-add plans may accept lower coverage on current income because they are underwriting the future business plan.
Lenders apply their own assumptions to NOI — a vacancy factor, a management fee, replacement reserves and the property tax bill that will apply after the sale — so their DSCR is often lower than a seller’s. The final loan is the smaller of the amount allowed by DSCR and the amount allowed by the loan-to-value limit.
Why DSCR matters after closing
Many commercial loans include DSCR tests during the loan term. Falling below a set level can trigger a cash sweep, in which excess cash is held by the lender instead of distributed, or other lender protections. Rising insurance and tax bills or a floating-rate payment increase can push coverage down even when rents are steady, which is why conservative underwriting leaves room above the minimum.
For passive investors, DSCR is one of the most useful health checks in a sponsor’s reports. A building that has drifted close to 1.0x has little room for surprises.
