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Debt Coverage Ratio

Lenders making commercial loans use debt coverage ratio (DCR) to determine how much money they will loan on a property. Remember, with a commercial loan, the bank is underwriting the properties ability to pay the mortgage not yours. Commercial properties are viewed as businesses, and the lender wants to ensure that the business can run successfully.  The lower the the DCR the riskier the loan. When DCR goes below 1, the property negative cash flows. Commercial Lenders won’t loan on property that doesn’t cash flow.  Occasionally they will make an exception to this rule for a strong borrower who has a schedule of real estate owned and cash flow from other investments- they do this in the expectation that as time progresses and inflation raises prices that in 2-3 years the property will begin to positive cash flow. Expect to pay a penalty on interest rate if they give you a very low DRC loan.

Lender’s usually want a minimum DRC of 1.15-1.2, meaning that the NOI is at least 115% to 120% greater than debt service. Higher DCR (such as 1.25, even up to 1.55) may mean lower interest rates to the borrower.

The debt coverage ratio is the property’s net operating income divided by the annual debt service (12 months of mortgage payments).

Example Table:


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