A DSCR of 1.25 Is the Lender's Cushion, Not Yours

The supported debt service is not a loan amount

The 120,000 this property supports is an annual payment, and turning it into a loan needs a rate and a term. Ten thousand a month over twenty-five years is worth about 1,711,000 borrowed at 5 %, about 1,895,000 at 4 % and about 1,415,000 at 7 %. The building did not change between those three lines; nothing about the tenants, the rent or the roof is different. Rates alone moved what the same income can carry by nearly half a million, which is why a valuation that was fine at signing can fail its covenant at refinancing without a single thing going wrong on site.

What belongs in net operating income

Rent collected, less everything it costs to keep the property let: management, insurance, ground rent, maintenance, non-recoverable service charges and a realistic allowance for vacancy. Not the loan payment, which is the denominator, and not depreciation, which is an accounting entry rather than money leaving the account. The line most often left out is the reserve for capital repairs — a roof or a boiler does not appear in any given year and then appears all at once, and a coverage ratio computed without a sinking fund describes a building that never ages.

Frequently asked questions

What happens if the ratio breaches during the loan?

That depends entirely on the wording of the agreement, and it is worth reading before signing rather than after breaching. Common consequences range from a cash trap — surplus rent is held in a blocked account instead of being distributed — through a mandatory partial repayment to bring the ratio back, up to a formal event of default that lets the lender call the loan. Many agreements also give a cure period and a right to inject equity. The difference between those outcomes is a paragraph, not a market convention, so ask which one applies to you.

Does an interest-only loan improve the ratio?

Mechanically yes, because removing the principal from the denominator makes the payment smaller and the ratio larger, and that is exactly why lenders often specify which version their covenant is measured on. The debt does not get smaller, though — it waits at the end of the term, when the whole balance has to be refinanced or repaid at whatever rates and values exist then. A ratio that only clears because principal was deferred is describing a smaller monthly obligation and a larger single one.