Buying investment property means knowing your numbers. DSCR is one of the most important, whether it’s a single-family home, a duplex, a portfolio of single-family rentals, or a multifamily building. It tells you your risk and profit potential.
DSCR stands for Debt Service Coverage Ratio. You’re weighing the income your property brings in against the cost of operating it. The payment on your loan - the principal and interest - is a big part of those expenses. But there are also other ordinary ones, like:
- property taxes,
- insurance,
- and homeowners’ association dues.
That monthly payment and recurring costs added together are sometimes summarized as PITIA. DSCR = Rental Income/monthly PITIA.
Now suppose you have a property that rents for $1,000 a month. The loan payment is $550, the insurance is $100 and the taxes another $100, and then there are $50 in HOA fees. That’s a total of $800 a month in PITIA.
$1,000 rental income divided by $800 in PITIA gives you a ratio of 1.25.
A riskier situation is if your PITIA is higher than the income the property brings in. Then you’re losing money every month, instead of breaking even.
Suppose your PITIA is $1,200, a bit more than in the previous one. But you’re only getting $1,000 a month in rent. If you do the division, that’s a DSCR of 0.83.
With a DSCR under 1, you must raise your rents, refinance the property, or perhaps both to bring the property into the black.
Exactly 1 is when income exactly equals PITIA.
Say your rental property has a PITIA of $1,000 a month. Your rent brings in $1,000 a month. So the DSCR is 1.00.
If the ratio is exactly 1, then the rent covers the PITIA, but nothing else. If nothing ever goes wrong, the property will get by. But you won’t get rich, and there is no cushion for unexpected costs or delays. That’s better than a loss, but you don’t want to stay there.
When your DSCR clears 1.0, the rent can cover your PITIA. But that’s cutting it fine, as PITIA doesn’t include all your expenses. PITIA leaves out some expenses that don’t come up every month, like:
- repairs like repainting,
- capital expenses like a new roof or water heater,
- property upgrades and improvements, such as new kitchen countertops,
- and those months when the property sits vacant.
The key to being truly comfortable is a DSCR of 1.3 or higher. Everything left over above what you need for maintenance and repairs is pure profit.
Say, for example, the rental brings in $1,000 a month, and the PITIA is $750 a month. Then $1,000 divided by $750 is a DSCR of 1.33.
Typically, an investor with more doors in their portfolio can accept a lower minimum DSCR per property. An investor with an SFR portfolio (single-family rentals) might set it around 1.2. The larger number of properties gives them more cash available to deal with repairs.
For example, suppose your portfolio brings in $5,000 in monthly rental income and has a PITIA of $4,000 a month. Then $5,000 divided by $4,000 gives a DSCR of 1.25.
That leaves $1,000 a month for all the non-PITIA operating expenses, or $12,000 a year. The portfolio still makes money.
A DSCR Can Actually Be Too High
Like any other ratio, the higher DSCR is better. However, a DSCR can actually be too high.
But what’s optimal depends on the investor’s investing strategy. There are two very different, but both sound approaches.
In the first, suppose a retiree lives off the income from a rental property. If the property is already paid off, then they have no debt on it. So there’s no principal or interest payment for the calculation. They get $1,000 a month in rental income, and their PITIA is just $250. $1,000 divided by $250 is a DSCR of 4.0. That’s not just low risk, but a very strong return. For the retiree in this example, the DSCR of 4.0 might be just right.
In the second, an investor can grow their rental portfolio faster by doing cash-out refinancing. That’s taking equity from one property and turning it into cash to put toward buying a second property. For that growth investor, each property has to bring in enough income to pay its own PITIA, with a little left over. But if you’ve gone to too high a DSCR, you’re missing opportunities for new deals.
An important part of getting into real estate investing is knowing how to calculate DSCR. But you also need to decide what DSCR you’re looking for. Set guidelines that fit your own investment strategy. Then you go find deals and work with lenders to finance them.
About Delancey Street
Delancey Street is a premier, and award winning, business debt settlement company that helps business owners nationwide. Our goal is simple: help you escape debt in a safe and legal manner. Based out of New York, we can help in 49 of 50 states. We tell you how it is; because your business and future is on the line.
