Debt service coverage ratio (DSCR) calculations are more important than ever in determining the loan amounts for which your multifamily apartment can qualify. With increasing property values and minimal rent increases, debt service coverage can become a limiting factor in qualifying for requested loan amounts.
DSCR coverage minimums and restraints play an important role as safeguards for lenders against over leverage. The lender ensures that the monthly principal and interest payments can be made from the cash flow from both current and historical rental income. Maintaining a high DSCR reduces risk to the lender, as well as the borrower. Lenders want to make sure that even with decreased occupancy or demand, a project will bring in enough cash flow to cover the mortgage payments until higher occupancy or demand is achieved.
It is important to understand how the debt service coverage affects your requested loan amount whether you are refinancing or purchasing a multifamily apartment project.
The DSCR calculation can be figured out by taking the NOI (Net Operating Income) and dividing it by the annual PITI (Principal and Interest Payment)
DSCR 1.5 = $1,500,000 NOI / $1,000,000 Annual Principal & Interest Payment
In the example above, the NOI can cover the annualized debt payment by 1.5 times. This provides enough cash flow to cover unexpected expenses or vacancies due to a decrease in demand. Properties that incur unexpected expenses and a large decrease in occupancy risk falling below a DSCR of 1% to cover the minimum principal and interest payments. These projects will either need additional capital from investors or have to be subsidized by other cash flowing projects until the occupancy percentage is increased. Under such circumstances, these projects become a serious risk for default.
How to Increase Net Over Income
There are several ways that project owners can increase their NOI.
- Increase curb appeal with landscaping, exterior maintenance, signage, fencing or painting.
- Adding amenities such as a pool, clubhouse, playground, grills, hiking paths or a fitness center.
- Remodeling kitchens and bathrooms to increase rents and occupancy.
- Increase lease rates and terms.
- Getting at least three estimates for any vendor whether it be for security, maintenance, software, insurance or any other service.
Another way to increase the NOI and reduce the debt service coverage ratio is by reducing expenses. This can be achieved in the following ways.
- Implement a preventative maintenance program to fix repairs or issues timely, so that the potential for a more serious problem is eliminated.
- Upgrade technology to make it easier for tenants to have their service requests completed in an efficient and timely manner.
- Appealing the tax bill for the property.
- Utilizing LED lighting to reduce the amount of electricity used.
- Implement water reduction strategies in kitchens and bathrooms to reduce consumption.
These are just some of the ways that project owners can help themselves better qualify for the maximum amount of proceeds available during the refinancing process.