I am and have always been very excited about real estate, but writing about real estate investing is a slippery slope. Crossing the thin line from excited but realistic into sounding like a guru with unrealistic promises and projections of reaches is a very real danger; especially when writing about nothing down investing, also known as $0 money down.
The trouble, for me, is that nothing down is indeed my claim to fame. This is how I’ve built my portfolio, and this is what’s enables me to now reverse the Time Paradigm, which I talked about in an earlier article.
What’s Most Important
What set’s me apart, and what has enabled my success, is that my focus has always been and continues to be on safety first and investment returns second. Purchasing property with 100% leverage can be dangerous indeed, unless, that is, the analysis is geared toward safety at every step of the way. With this in mind, I need to talk to you today about the single most important metric – DSCR.
I don’t mean to always be contrarian, though most of the time I end up being exactly that — and my thoughts related to DSCR are no exception to that rule.
Debt Service Coverage Ratio (DSCR) is one of the measurements in the world of real estate investing that most investors pay very little attention to, while to me, it is one of the most important! Incidentally, it also happens to be the most important metric to the financiers, whether it be institutional or private.
What Is NOI?
Most people tend to judge the book by its cover, so to speak, and relative to DSCR, the classical definition is that this metric juxtaposes the Net Operating Income (NOI) to the debt service (mortgage payments). But first, let’s take a step back:
Question: What is NOI?
Answer: NOI is what is left of the Gross Yield (Gross Income) of an income-producing asset after all Operating Costs. Important to understand is that the Operating Costs do not include debt service. Thus, the formula for NOI is:
NOI = Yield – Operating Costs
What About the Mortgage Payment?
Well, if you paid all cash, then there is no mortgage payment. And if you financed any portion of the purchase price, then the mortgage payment needs to come out of the NOI.
What Is DSCR?
DSCR identifies the relationship of the total amount available for debt service, which is NOI, with the actual amount of debt service resulting from your financing. For example, if the NOI on a building is $1,000/month and the combined monthly debt service (monthly mortgage payments) are also $1,000, then the DSCR is 1.0:
DSCR = NOI / Debt Service = $1,000 / $1,000 = 1.0
What Does This Mean?
Well, in plain English, this means that after you pay the mortgage payment of $1,000, there is going to be nothing left. This in turn means 2 things:
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