How is the debt service coverage ratio (DSCR) calculated for a stabilized property loan, and what does a DSCR greater than 1 signify?

• A. DSCR = annual debt service / NOI; indicates a cushion if greater than 1.
• B. DSCR = NOI / annual debt service; indicates a cushion if greater than 1.
• C. DSCR = NOI / taxes;
• D. DSCR = cash flow / principal;

Answer: (B)

The main idea is to compare the property’s ongoing income to the debt payments it must make. For a stabilized property loan, the ratio is Net Operating Income divided by annual debt service. NOI is the income from rental operations after operating expenses, before financing costs and taxes. Annual debt service is the total principal and interest payments due in a year. When this ratio is greater than 1, NOI exceeds debt service, giving a cushion to absorb vacancies, rent declines, or higher operating costs. Lenders usually look for a DSCR above 1 (often 1.2–1.25 or higher) to ensure the loan is adequately protected. Using the inverse (debt service divided by NOI) would misstate coverage, and taxes or principal alone aren’t the components of DSCR.