To
understand the ratio, it is first necessary to understand the numerator and
the denominator.
Net
Operating Income is the income from a income property left over after paying
all the operating expenses.
Gross scheduled Rents $100,000
Less 5% Vacancy $5,000
Effective Gross Income: $95,000
Less Operating Expenses
Real Estate
Taxes
Insurance
Repairs &
Maintenance
Utilities
Management
Fees
Reserves for
Replacement
Total Operating Expenses:
$30,000
Net Operating Income (NOI) $65,000
Note
that lenders always insist on some sort of vacancy factor regardless of the
actual vacancy to cover collection loss. In
addition, lenders always insist on using a management fee factor of 3-6% of
effective income, even if the property is owner-managed. Their logic is that they would have to pay
for management if they took back the property.
Next,
the denominator, Total Debt Service. This
includes the principal and interest payment on the property, not just the first
mortgage.
To
calculate the debt service coverage ratio, divide the net operating income (NOI)
by the mortgage.
Mortgage = $500,000
11%
interest, 30 years amortized
Annual
Payment (Debt Service) = $57,139
Then:
DSCR
= Net Operating Income (NOI) = $65,000
Total
Debt Service = $57,139
DSCR
= 1.14
