One property at five coverage levels: the income cushion, the rate headroom and the loan each DSCR buys.
A DSCR of 1.25x is the usual floor for a stabilised commercial loan, and the reason is arithmetic: at 1.25x net operating income can fall 20.0 per cent before it no longer covers debt service, because the cushion is 1 − 1 ÷ DSCR. At 1.10x the cushion is only 9.1 per cent; at 1.50x it is 33.3 per cent. A "good" DSCR is therefore the one whose cushion matches how far the property's income could realistically fall, which is why illustrative lender minimums run from 1.20x for let apartments to 1.40x or more for hotels.
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The ratio itself is simple: NOI divided by annual debt service, interest and principal. What it buys is less often shown. Below, one property is run through five DSCR levels to show the income cushion, the interest rate headroom and the loan each level allows.
| Input | Value |
|---|---|
| Underwritten NOI | 2,000,000 |
| Interest rate, fixed | 6.50% |
| Amortisation, monthly payments | 25 years |
| Mortgage constant (annual debt service ÷ loan) | 8.10% |
| Property value at a 6.00% cap rate | 33,333,333 |
DSCR = NOI ÷ annual debt service
NOI cushion = 1 − 1 ÷ DSCR
Maximum loan = NOI ÷ DSCR ÷ mortgage constant
In Excel, the constant is =-PMT(6.5%/12,25*12,1)*12, 8.10 per cent. With NOI in B2, the DSCR in B3 and the constant in B4, the loan is =B2/B3/B4 and the cushion =1-1/B3.
At 1.25x the debt service allowed is 2,000,000 ÷ 1.25 = 1,600,000 a year, which at an 8.10 per cent constant supports a loan of 19,747,026. With monthly payments, 1,273,957 of the first year's payments is interest and 326,043 repays principal. NOI can drop to 1,600,000, a fall of 20.0 per cent, before the property stops paying its own debt.
| DSCR | Debt service | Loan | LTV | NOI cushion | Rate at 1.00x | Rate headroom |
|---|---|---|---|---|---|---|
| 1.10x | 1,818,182 | 22,439,802 | 67.3% | 9.1% | 7.56% | 106 bp |
| 1.20x | 1,666,667 | 20,569,819 | 61.7% | 16.7% | 8.57% | 207 bp |
| 1.25x | 1,600,000 | 19,747,026 | 59.2% | 20.0% | 9.07% | 257 bp |
| 1.35x | 1,481,481 | 18,284,283 | 54.9% | 25.9% | 10.04% | 354 bp |
| 1.50x | 1,333,333 | 16,455,855 | 49.4% | 33.3% | 11.45% | 495 bp |
"Rate at 1.00x" is the interest rate at which the same loan, on the same amortisation, would absorb the whole NOI: the relevant number for a floating-rate loan or a refinancing. At 1.25x there are 257 basis points of rate headroom; at 1.10x only 106.
A DSCR is good when its cushion is larger than the income fall the property could suffer before the loan is repaid. That is why lenders set different minimums by asset type. The figures below are illustrative of how the logic runs, not quoted market terms.
| Property | Minimum DSCR | NOI cushion |
|---|---|---|
| Multifamily, stabilised | 1.20x to 1.25x | 16.7% to 20.0% |
| Industrial, let | 1.25x to 1.35x | 20.0% to 25.9% |
| Office, multi-let | 1.35x to 1.50x | 25.9% to 33.3% |
| Hotel | 1.40x to 1.60x | 28.6% to 37.5% |
A hotel's income resets nightly and an office can lose a floor at one lease expiry, so both need more cushion than a block of apartments with hundreds of small tenants. Each step of cushion costs proceeds: moving from 1.25x to 1.50x gives up 3,291,171 of loan, 16.7 per cent, while dropping to 1.10x adds 2,692,776 and leaves a 9.1 per cent margin.
The cushion is measured on the lender's underwritten NOI, after a vacancy allowance, a management fee and capital reserves, not on the borrower's trailing figure. A loan sized at 1.25x on underwritten NOI can read 1.40x or more on the borrower's own numbers, and the gap between the two definitions is often larger than the gap between two lenders' minimums. How the agreement defines both sides of the ratio is covered in how to calculate DSCR under a commercial loan agreement.
The same 19,747,026 loan on interest-only terms costs 6.50 per cent a year instead of 8.10, so its DSCR reads 1.56x rather than 1.25x, and the rate could rise to 10.13 per cent before cover hits 1.00x. A DSCR quoted without the amortisation basis is therefore not comparable with another. At 1.50x amortising the interest-only reading is 1.87x; at 1.10x it is 1.37x.
A DSCR of 1.25x means income can fall 20.0 per cent before the debt is uncovered; 1.50x means 33.3 per cent. Choose the level by how far the property's income could fall, check it on the lender's NOI and the amortising payment, and test the rate as well as the income. Real Estate Finance sizes one loan on all three tests and names the one that binds; the free workbooks for this case solve each test for the income fall that breaks it.
For a stabilised, granular asset such as let apartments it is often acceptable: income can fall 16.7 per cent before debt service is uncovered. On this property 1.20x supports a 20,569,819 loan with 207 basis points of rate headroom. For an office or hotel whose income can drop sharply at one event, the cushion is thin.
Net operating income exactly equals debt service, with nothing left over. Any fall in income, or any rise in a floating rate, means the owner must fund the shortfall. On the 1.25x loan here cover reaches 1.00x if NOI falls to 1,600,000 or the rate rises from 6.50 to 9.07 per cent.
Because the debt service excludes principal. The same 19,747,026 loan costs 1,283,557 a year interest-only at 6.50 per cent against 1,600,000 amortising over 25 years, so cover reads 1.56x instead of 1.25x. Always state the amortisation basis with the ratio.
Sizing a loan on loan-to-value, debt service cover and debt yield, and naming the test that binds, is the subject of chapter 4 of Real Estate Finance. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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