- DSCR = Net Operating Income ÷ Annual Debt Service. Most lenders require a minimum of 1.25x.
- Lenders calculate their own "underwritten NOI" — which is almost always lower than the borrower's stated NOI.
- The debt constant (annual debt service as a % of loan balance) determines how much NOI you need for a given loan size.
- DSCR and LTV act as twin constraints — a deal must satisfy both simultaneously.
- A 1.0x DSCR means the property barely breaks even on debt service — lenders need cushion above that.
Every commercial real estate lender, regardless of loan type, runs the same fundamental calculation before approving a loan: does the property generate enough cash flow to service the debt with a meaningful cushion? That calculation is the Debt Service Coverage Ratio (DSCR), and it is the single most important metric in CRE underwriting. Understanding how lenders really calculate it — not how borrowers present it — is essential for anyone financing a commercial asset.
The DSCR Formula
DSCR = Net Operating Income (NOI) ÷ Annual Debt Service
NOI is effective gross income minus operating expenses (excluding debt service). Annual debt service is the total of principal and interest payments over 12 months. A DSCR of 1.25x means the property generates $1.25 in NOI for every $1.00 in debt service — a 25% cushion above breakeven.
Example: A hotel generates $1.5M in NOI. A CMBS lender requires a 1.25x minimum DSCR. The maximum supportable annual debt service is $1.5M ÷ 1.25 = $1.2M. At a 7.0% rate with 30-year amortization, the debt constant (annual payment per dollar of loan) is approximately 7.98%. Maximum loan size = $1.2M ÷ 0.0798 = $15.04M.
How Lenders Underwrite NOI (It's Not What You Think)
The most important thing to understand about DSCR underwriting is that lenders do not use the borrower's stated NOI. They calculate their own "underwritten NOI" using conservatized assumptions. Typical lender adjustments:
- Revenue: Use trailing 12-month actual, but haircut any one-time revenue items or above-market performance. Apply a stabilized vacancy/credit loss of 5–10% even if the property is currently 95% occupied.
- Management fee: Gross up to a market-rate management fee (typically 3–5% of revenue), even if the owner self-manages at no cost.
- Capital reserves: Add a replacement reserve of $250–$500/unit (apartments) or 3–5% of revenue (hotels) as an operating expense line.
- Stabilized expenses: Use the higher of actual expenses or market-comparable expenses for the asset type and market.
The result: lender-underwritten NOI is typically 10–20% below the borrower's stated NOI. This is intentional — it builds in a buffer against optimistic projections.
DSCR and LTV: The Twin Constraints
A loan must satisfy both DSCR and LTV simultaneously. LTV sets the maximum loan as a percentage of appraised value. DSCR sets the maximum loan as a function of cash flow. The binding constraint — whichever produces a lower loan amount — is what determines your actual loan size.
In a low-cap-rate environment, cash flow (DSCR) is often the binding constraint. In a high-cap-rate environment with strong NOI, LTV is often binding. Understanding which constraint is binding on your deal tells you where to focus negotiations.
Sensitivity: How DSCR Changes with Rate Moves
| Loan Rate | Debt Constant (30yr am) | Max Loan at $1.5M NOI / 1.25x |
|---|---|---|
| 5.50% | 6.82% | $17.6M |
| 6.50% | 7.59% | $15.8M |
| 7.00% | 7.98% | $15.0M |
| 7.50% | 8.39% | $14.3M |
| 8.00% | 8.80% | $13.6M |
First Realty Capital builds detailed DSCR models for every loan we underwrite. Request a free underwriting analysis for your property.
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