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Calculating The Debt Service Ratio For A Commercial Loan Proposal – Winston Rowe & Associates
Commercial mortgage lenders look to a loan proposal as evidence that your property is strong, understanding the data and math associated with the debt service ratio (DCR) will enhance the chances you'll receive financing.
When a commercial real estate lender is carefully reviewing your financing request, they are focusing on the prospective borrowers ability not only make their monthly mortgage payments, but also show a profit and maintain cash reserves for future contingencies.
The commercial lender relies on the debt coverage ratio (DCR) and net operating income (NOI) as key factors in their due diligence for your financing request.
It's important to understand the concept and math behind the DCR if you are calculating your own cash flow analysis for a prospective commercial real estate loan, whether it's a purchase or refinance.
This is how you arrive at the debt service ratio (DCR).
First, calculate the gross operating income (GOI) also known as the effective gross income (EGI) which equals the property's annual gross scheduled income less vacancy and credit loss. The GOI is not the property's potential income, but represents instead the actual income that you expect.
Gross Operating Income = Gross Scheduled Income less Vacancy and Credit Loss
Second, calculate the net operating income (NOI) which is the commercial properties income after being reduced by vacancy and credit loss and all operating expenses. This represents the properties profitability before taxes, financing and recovery of capital.
Net Operating Income = Gross Operating Income less Operating Expenses
Third, calculate the annual debt service (ADS) which is the total of all principal and interest payments made over the course of a year.
Annual Debt Service = Monthly Payment X 12
Finally, calculate the debt service ratio (DCR) which is the ratio between the property's net operating income (NOI) for the year and the annual debt service (ADS).
Debt Coverage Ratio = Annual Net Operating Income / Annual Debt Service
Most commercial real estate lenders look for a DCR of at least 1.20, often even more. A property with a 1.20 DCR has income before debt service, that is 1.20 times as much as the debt service – in other words, the commercial property generates 20% more net income that it needs to make its mortgage payments.
When you are developing your commercial real estate financing proposal for a lender, you can be certain that the lender will carefully examine the DCR and the data that was utilized.
Winston Rowe & Associates is a no upfront fee commercial real estate advisory and due diligence firm that specializes in the financing of commercial real estate transactions.
They actually want to speak with clients directly, so they can truly understand their business and its distinct needs.
The best funding solutions occur when they combine data with consultation and common sense.
They can be contacted at 248-246-2243 or visit them online at http://www.winstonrowe.com