Updated · Part of the CRE investment glossary
How DSCR works
DSCR measures the cushion between what a property earns and what its loan costs. At 1.00x, NOI exactly pays the loan and nothing is left for capital work or distributions. Below 1.00x, the owner has to fund the shortfall.
Lenders use DSCR twice. At origination, it caps the loan amount: the lender works backward from NOI and its minimum ratio to the largest payment, and from the payment to the loan. After closing, the loan documents may require the owner to test DSCR periodically.
The formula
Use the same annual period for both figures:
DSCR = NOI ÷ annual debt service
- NOI: the lender’s underwritten net operating income, which may differ from the seller’s or yours.
- Annual debt service: twelve months of principal and interest payments on the loan.
- Some lenders use net cash flow (NOI minus reserves) instead of NOI. The loan documents define it.
Worked example: amortizing vs interest-only
A property produces $600,000 of NOI. The buyer wants a $7,000,000 loan at 6.5%. With 30-year amortization the payments are $530,937 a year and DSCR is 1.13x — below a 1.25x minimum. With interest-only payments of $455,000 a year, DSCR is 1.32x.
Sized to 1.25x on a 30-year amortizing basis, the maximum annual debt service is $600,000 ÷ 1.25 = $480,000, which supports a loan of about $6,328,433. The buyer brings the difference in equity.
| Loan structure | Annual debt service | DSCR |
|---|---|---|
| $7,000,000, 30-year amortization | $530,937 | 1.13x |
| $7,000,000, interest-only | $455,000 | 1.32x |
| $6,328,433, 30-year amortization | $480,000 | 1.25x |
How lenders size a loan
DSCR is rarely the only test. Lenders commonly size a loan on several constraints at once — loan-to-value, DSCR and sometimes debt yield (NOI ÷ loan amount) — and lend the lowest result. Continuing the example, assume an appraised value of $9,500,000, a 70% maximum loan-to-value, a 1.25x minimum DSCR and a 9% minimum debt yield.
Here DSCR binds: the loan is about $6,328,433, not the $6,650,000 that loan-to-value alone would allow. When rates rise, DSCR usually becomes the binding test sooner, because the same NOI supports a smaller payment-based loan.
| Constraint | Calculation | Maximum loan |
|---|---|---|
| Loan-to-value 70% | 70% × $9,500,000 | $6,650,000 |
| DSCR 1.25x | $480,000 a year of debt service | $6,328,433 |
| Debt yield 9% | $600,000 ÷ 0.09 | $6,666,667 |
| Loan offered | Lowest of the three | $6,328,433 |
DSCR as a covenant
Many commercial loans set a DSCR test that the property must keep passing, often measured quarterly or annually on trailing NOI. Falling below it can trigger cash management, a reserve requirement or other remedies the loan agreement sets out. Read the definition carefully: which NOI, which period, and whether debt service is actual or hypothetical.
In the example above, a 10% drop in NOI to $540,000 takes the amortizing loan to 1.02x, close to break-even. That is why sponsors track coverage every period, not just at closing.
Common mistakes
DSCR is simple arithmetic, so the errors are in the inputs:
- Using pro forma NOI when the lender will size on trailing NOI.
- Calculating coverage on interest-only payments and forgetting when amortization starts.
- Ignoring a rate reset or a floating rate, which changes debt service without any change in NOI.
- Assuming one lender’s minimum applies to another; it varies by lender, property type and loan program.
General information, not legal, tax or investment advice. Your operating agreement, offering documents, counsel and CPA govern your deal.