Debt Service Coverage Ratio

DSCR is calculated by dividing a property's annual NOI by its total annual debt service (principal plus interest). A DSCR of 1.0 means the property generates exactly enough income to cover its loan payments with nothing left over. Most commercial real estate lenders require a minimum DSCR of 1.20 to 1.35, meaning the property must generate 20-35% more income than needed to service the debt. Higher-risk property types or borrowers may face DSCR requirements of 1.40 or above.

DSCR is one of the most important constraints in deal structuring because it often determines the maximum loan amount. Even if a borrower qualifies for a higher loan-to-value ratio, the DSCR requirement may limit actual proceeds. For example, a property with $250,000 in NOI and a lender requirement of 1.25x DSCR can support maximum annual debt service of $200,000. If the loan terms result in higher payments, the loan must be sized down regardless of the LTV.

Investors should stress-test DSCR under different scenarios: rising interest rates (for floating-rate loans), increased vacancy, or rising operating expenses. A deal that barely meets the DSCR threshold at acquisition may violate loan covenants if performance dips, triggering cash sweeps or even default. Conservative underwriting typically targets a DSCR of 1.30 or higher to build in a buffer against market fluctuations.