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Debt Service Coverage Ratio, with Erik J. Olson

Episode #1298

DSCR or Debt Service Coverage Ratio means that your bank will lend you a big amount of money for a real estate investment. In this episode, Erik shares how much the possible loan you can get when you invest in real estate.

August 5, 2022

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Episode Transcript

Erik J. Olson (00:02):

Let’s talk about debt, service, cover ratios. What is happening? This is Erik J. Olson. All right. DSCR I’m gonna get all nerdy on you. When it comes to real estate investing your DSCR is your debt service coverage ratio. Now what this means, and this is something I’ve learned at the real estate summit held by Grant Cardone in July, down in Miami. What this means is that your bank will only lend you so much money for a real estate investment. When you’re buying real estate as an investment, it’s a completely different kind of like evaluation. As when you’re buying a single family home for your family to live in. When you buy a single family home, you’re evaluating it based on like what the other houses in the neighborhood went for. And really what they do is they figure out the square footage, price of a home in your neighborhood, two or three or four of them.

Erik J. Olson (00:58):

And then they just extrapolate it to whatever square footage you have in the home you wanna buy. And that’s basically the basis of the appraisal with commercial real estate investing. It’s it’s not, it’s not like that. The way that it works is, is based on the income that a property produces. So if you think about like, let’s just keep this kind of like a simple example. Let’s say you have 10 apartments in a building that you wanna buy. And each one of them rents for $1,000 per month. That’s $10,000 of gross revenue or gross income per month. But out of that, you have to reduce it for several factors. One factor is what’s the occupancy rate that you expect to get out of that property. Let’s say it’s 90%. So now you you’re coming down from $1,000 per unit per month, times 10 units or 10,000 total per month.

Erik J. Olson (01:55):

You’re gonna bring it down to 9,000 because nine out of 10 times it’ll be rented one out of 10. It won’t right. Simple example, $9,000 a month. Now, now let’s say that your expenses are actually about $4,000 a month. That brings your net operating income, the bottom line number before you pay your mortgage to about $5,000 on this example. All right, let’s, let’s walk through that again. And then I wanna get to the debt service coverage ratio, $1,000 a month per unit times 10 units is a maximum of $10,000 per month. You’re gonna reduce that by 10%, because there’s gonna be vacancies, right? You’re gonna have a vacancy every once in a while in your unit. And let’s say about 10% of the time that brings you down to $9,000 a month. And then if you have $4,000 of expenses, again, I’m keeping this really simple for you.

Erik J. Olson (02:48):

You know, so I’m trying to talk through this and keep these numbers in my mind as well. Outta that 9,000 and 4,000 goes towards your expenses. Then you basically gross profit $5,000 a month. Now in real estate investing, we call that net operating income of $5,000 per month. Then the question is how much debt can you get on $5,000 of net operating income per month? And this is where the debt service coverage ratio, man, I almost forgot what it’s called. The debt service coverage ratio comes into play. And this is what I’ve learned at the real estate summit is that most banks will give you a debt service coverage ratio of 1.25. Oh. And by the way, when I came back and I verified that with my banker who I’ve done deals with 1.25, he said is what they loan to. So what that means is the property has to bring in 1.2, five times, whatever the mortgage payment is.

Erik J. Olson (03:51):

All right. What I said before in that other example was $5,000, is, is your net operating income. So if you take $5,000 and now you divide it by 1.25, that means that your mortgage payment. And I did this on a calculator. You can, if you’re watching the video, you can see this, your mortgage payment can be no more than $4,000 per month. Now what that means is the, the bank will only lend you as much as the property itself can support. It has very little to do actually with you, the person trying to get the loan and much more so with the property. So if your property’s bringing in $5,000 a month, they will lend you a loan that has a total principle and interest payment of $4,000 a month. Cause they wanna make sure that your property can pay for itself, right? That’s what they’re trying to do with that debt service coverage ratio.

Erik J. Olson (04:47):

So if your payment, your principle and interest is $4,000 a month. Then the next question is how big of a loan can you get with the payment of $4,000? And by the way, there’s a formula in Excel that will calculate this for you. I don’t have it in front of me, but I do have the spreadsheet that I use to evaluate deals now. And I do this exact calculation. It’s very simple. Once, you know, the amount of the payment, you know, how long the term is on the loan and you know, what the interest rate is, then it will back calculate the maximum loan, which is really like a present value equation. But that will tell you how big of a loan you can get. And then you can, can compare that against how much you’re willing to offer. And the difference is how much you need to come out of pocket for that property. So the debt service coverage ratio, the DSCR sometimes referred to as a DCR is a very important number 1.25. And it seems to be a constant with most banks, but you should always find out what that is, how much will they loan you? How much will the banks lend you for a property, find that out. And then you can back into

Erik J. Olson (05:56):

How big of a loan you can get. That was a piece of information that I didn’t exactly understand, which is one of the big, big takeaways from that real estate summit that I went to in July of 2022. So like here, here’s, here’s the moral of the story. If, if there, if you’re looking to get into something, especially when you money is on the line, you should really understand fairly well what you’re doing. And I was missing this one piece of the puzzle and now I’ve got it right? So I feel very confident. Now when I look at properties, I can tell if they’re money makers or not think about, you know, your gaps in your skills, think about what you wanna do in the future and what gaps that entails and start filling in those gaps. By talking to people, studying videos, watching videos, going to conferences like I did with the real estate summit, getting a coach, do something to fill those gaps in. Cuz if you really want to Excel in life, you’re gonna have to fill those gaps in, but only you can take the action to get those gaps filled.

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About The Hosts

  • Erik J. Olson is an award-winning digital marketer & entrepreneur. The Founder & CEO of Array Digital, he is also the host of the Journey to $100 Million Flash Briefing and daily podcast, and the organizer of the Marketers Anonymous monthly meetups.

  • Kevin Daisey is an award-winning digital marketer & entrepreneur. He started his first company when he was just 23, and is the Founder & CMO of Array Digital. Kevin is the also the co-host of the Journey to $100 Million Flash Briefing and daily podcast, and the co-organizer of the Marketers Anonymous monthly meetups.

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© Array Digital LLC