What is Debt Service Coverage Ratio?
For rental property investors a key factor in determining the value of a potential rental property is the DSCR, or the Debt Service Coverage Ratio. The Debt Service Coverage Ratio is calculated by dividing the monthly rental income by the monthly expenses of owning the property. Monthly expenses include the principal, interest, taxes, insurance, and if applicable the homeowner’s association dues that are owed on the home every month, these expenses are commonly referred to as PITIA.
To give an example let’s say that an investor buys a cash-flowing rental property in Atlanta, GA and expects to be able to charge $1,400/month for rent with the PITIA on the property coming out to be $1,000 each month. Having a good understanding of DSCR, the investor divides the monthly rental income by the PITIA expenses to get a DSCR of 1.4. A DSCR of 1.4 will give the investor solid returns and they will be able to expect steady cash-flow from the property while it is tenanted. The minimum DSCR on a property that an investor should consider is 1.3 in order to keep the investor’s margins from being too thin and the overall quality of the investment high.
Understanding this calculation can help investors see the overall return on a property based on their estimated monthly income against the monthly expenses. Properties with a low DSCR will cost the investor money in the long run and being able to calculate DSCR can help investors to make smart choices when buying rental properties.
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