What Is DSCR?

DSCR (Debt service coverage ratio) is the ratio of a company's or its asset's net operating income to its debts and liabilities. DSCR takes the personal cash flow as the most critical denominator. It is an important parameter used by financers and lenders while giving loans to companies. The ratio helps them determine the company's ability to repay a real estate loan. 

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DSCR = Net Operating Income of the properties/ Annual debt service payments.

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You should include all of the following debt categories while calculating DSCR.

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• Loans from banks or online lenders
• Leases 
• Annual loan payments
• Short-term borrowings
• Invoices for finance
• Business credit cards 

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Difference Between DSCR And DTI

DTI (Debt to Income)

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Like DSCR, lenders use a debt-to-income ratio to determine the worthiness of a borrower in paying back the loans. However, DTI is specifically used by financers to make a decision of giving loans on residential properties. These can include-

• Single-family home
• Condo
• Duplex, etc.

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DTI = Individual's debt payment/Overall income

DSCR

The major distinction between DTI and DSCR is that the latter doesn't consider personal debt. In DSCR, commercial lending is rather based on real estate income, which lets financers and investors determine how the business loan will be repaid.

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DSCR vs DTI: What's suitable for giving loans to real estate investors?

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Financers and lenders always consider debt service coverage ratio loans for real estate investors. These investors might have a lot of expenses and thus, a lower DTR. However, that doesn't indicate lower revenues or cash flows for their businesses. Hence, DSCR is an excellent measure to identify a borrower's potential to repay the loan, regardless of their income.

How Is Bad DSCR Determined?

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A negative DSCR indicates a negative cash flow, which is considered to be a bad indicator. That means lenders will avoid offering loans to businesses with negative ratios. Contrarily, a positive DSCR will ensure your business gets the required loan in time.

The Importance Of DSCR For Businesses

Among business owners, the debt service coverage ratio has several important uses.

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1. Draft Corporate Strategy: Businesses use DSCR as a debt repayment measure to identify their current financial status and future borrowing decisions. Furthermore, companies formulate a corporate strategy, estimating a projected DSCR for the next two to three years based on existing revenue streams and future commitments.  

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2. Acquisitions: DSCR is a significant bank financing metric for business owners considering acquisitions. The DSCR of the target company is checked to estimate whether the newly acquired company will be able to increase current sales and generate enough revenue in the future. Companies only consider acquisitions of a target company with a DSCR ratio of more than 1.

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3. DSCR provides a detailed overview of the business's financial position and market performance.

How Can I Increase The DSCR?

Since DSCR involves a ratio analysis, there are two ways to increase the DSCR value.

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1. An increase in the numerator.
2. Decrease in the denominator.

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A combination of the following factors may result in significant improvements in DSCR. 

• Lower loan payments
• Higher sales, and
• Lower expenses.

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A higher DSCR also boosts your financial credibility, thus increasing your chances of further funding, which is an essential step in expanding your business.

Increasing The DSCR

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• Paying off the existing debt will increase the DSCR. If this isn't possible, consider refinancing your current loans for lower interest. This will improve the debt service rate.

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• Second, a business needs to ensure increased sales and higher earnings. However, this might be challenging to achieve for companies by the time they ask for DSCR. Businesses can either show more cash flow for their debt payments or agree on taking less compensation for the loan. 

Steps To Take If The DSCR Is Too Low For The Required Loan Amount

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If a business is left with such a bottleneck situation, there are 3 options.

• Drop the plan of taking a loan.
• Wait out any existing leases and increase the rent for the next fiscal year.
• Lower the required loan amount.

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Summary

Overall, DSCR is an essential component of commercial real estate. If you are looking for lenders who can finance your real estate asset, you need to show them that the loan will be paid back. Since DSCR reflects the funds a business can offer, lenders often consider DSCR the first and most important metric while lending. However, finding the right lender for a DSCR loan can be challenging. One best piece of advice is to always look for companies that have expertise in this niche market. 

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