I often get calls from aspiring investors looking to take advantage of the tremendous opportunity in multi-family real estate acquisition. When it comes to financing this type of real estate, I thought it would be a good idea to review an issue that plays a big role in the lending process.

DSCR stands for Debt Service Coverage Ratio. When lenders review your project, they estimate the ability of the property’s rental income to cover the proposed debt. So while an investor may highly consider an apartment building, a lender may not think so if the DSCR is below standard guidance (typically 1.20). In fact, DSCR is the traditional way a commercial property qualifies for financing.

So how do lenders determine the DSCR? There are two steps in the process.

1. NOI (net operating income) is first determined. So, here is the formula:

NOI = Total Rental Income – VC (Vacancy and Collections) – OE (Operating Expenses)

Generally, OE includes taxes, insurance, utilities, repairs and maintenance, property management, and reservations. While they do take into consideration the actual expenses provided by the seller, they often use their own formula at roughly 40-50% of gross receipts and apply the most conservative figure. CV is typically a percentage (about 5-10%) of total revenue that is assessed based on the history and condition of the building and area.

2. With an NOI figure, the next step is to determine the DSCR. Again, here is the formula:

DSCR = NOI/P&I

NOI is based on total annual income and P&I represents the projected annual principal and interest payments on the new loan. The terms of the new loan are very important in qualifying the property for financing. The interest rate and amortization are key factors. I’ll show you why in a moment. But first let me show you how you can easily find out if your deal is feasible when you show up for the lender’s evaluation.

In this example, let’s say you’re working with an annual gross income of $150,000. It has no actual expenses from the seller.

East. NOI = $150,000 X 50% (CV and EO) = $75,000

Next, let’s say your PP (purchase price) is $800,000 and your DP (down payment) is $250,000. The amount financed would be $550,000. we have 15 years amortization with a rate of 6% the monthly P&I would be $4,641 and the annual P&I would be $55,692.

DSCR = $75,000/$55,692 = 1,347

In this case, the property would be servicing the debt, and the lender would likely view the transaction favorably. However, he does not consider a favorable DSCR as an indication of loan approval. Now, if the loan amortization is over 10 years instead of 15, even if the rate is lower than in the initial example, say 5.5%, the property would not qualify.

DSCR = $75,000 / $71,627 = 1,047

Finally, there are other factors that also affect the transaction. On topic though, keep this in mind: 1) The DSCR should be at least 1.20 no matter how good everything else looks and 2) The higher the ratio, the better and easier the deal. to qualify.