What is Debt Coverage Ratio?
2 min read.
Debt Coverage Ratio (DCR), also known as Debt Service Coverage Ratio (DSCR), is a crucial metric in commercial real estate lending that measures a property's net operating income divided by its debt service. Lenders consider it a key factor when evaluating a company's creditworthiness and financial health, as it demonstrates the ability to generate income to cover debt obligations and avoid default.
A high DCR is generally regarded as a positive sign, indicating that the property generates more revenue than needed to cover debt obligations. Conversely, a low DCR suggests the property needs to generate more revenue to service its debt. A DCR of 1 or higher is generally acceptable for commercial real estate, indicating that the company generates sufficient income to cover its debt payments. However, most lenders prefer a DCR or DSCR of at least 1.25 times. Higher DCRs make it easier to secure loans with favourable terms such as longer fixed-rate terms, lower interest rates, non-recourse provisions, lower fees, and more minor prepayment penalties with shorter durations.
Lenders often require riskier property types to have significantly higher DCRs, such as hotels and self-storage facilities, which should have a DCR of at least 1.4 times due to high turnover and seasonal revenue fluctuations.
To optimize the DCR and improve the financial standing, it is important to advise your clients to focus on paying off existing debts and implementing cost-cutting measures. Maintaining a high DCR is essential for enhancing borrowing capacity and improving negotiating power with favourable loan terms.
References
DSCR: Debt service coverage ratio. Commercial Real Estate Loans. (2023, February 24). Retrieved May 1, 2023, from https://www.commercialrealestate.loans/commercial-real-estate-glossary/dscr-debt-service-coverage-ratio/#
What is the debt service coverage ratio (DSCR). BDC.ca. (n.d.). Retrieved May 1, 2023, from https://www.bdc.ca/en/articles-tools/entrepreneur-toolkit/templates-business-guides/glossary/debt-service-coverage-ratio#:~:text=The%20debt%20service%20coverage%20ratio%20(DSCR)%20is%20a%20key%20measure,%2Dto%2Dtotal%20assets%20ratio
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