Investment properties financing is essential in order for the investor to limit the amount of money he/she puts out of his/her pocket when investing in an income-producing properties; The Debt Coverage Ratio indicator or DCR finds out whether the property generates enough money to cover the debt for one year.
A DCR of 1.00 means you have exactly, greater than 1.00 means you have enough and some left, and less 1.00 means you don't have enough to pay the mortgage. Most banks like the property to have a DCR of 1.20 or higher before they give you a mortgage.
DCR= Annual Net Operating Income / Annual Debt Service
For example, an investor purchases a single home investment property for $62,000 with a monthly rent of $1,600, vacancy rate of 3%, monthly mortgage payments of $1,200, and total annual expenses of $3,000.
DCR= Annual Net Operating Income / Annual Debt Service
DCR= $15,624 / $14,400
Subtracting the annual expenses and vacancy rate from the annual rent income, and dividing it by the mortgage payments for the year calculates the DCR. Most investors employ the use of real estate investment software to calculate the debt coverage ratio.
Investor should know the DCR of each potential investment property. Real estate investment software often allows investors specified the benchmark level by which to accept or reject a property based on the DCR specified by the investor.
The following values have an impact on the Debt Coverage Ratio calculation:
MONTHLY RENT
VACANCY RATE
MORTGAGE PAYMENTS
ANNUAL EXPENSES
The annual expenses include maintenance, property taxes, and other expenses incurred y the operation of the property.
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