Apartment Buildings Hard Money

Apartment buildings hard money loans or any other commercial real property loans lenders use a key ratio called Debt Service Coverage Ratio (DSCR) to analyze whether sufficient cash flow is generated from the property to cover the principal and interest payments of the potential loan. DSCR is also known as Debt Coverage Ratio. The DSCR is calculated by dividing the Net Operating Income (NOI) by the Total Debt Service (Annual Mortgage Payment(s):

                              DSCR = NOI/Total Debt Service

The DSCR ratio is calculated on an annual basis and is expressed as 1.10 or 1.20 etc. For example, if the ratio is 1.20 it means the property is  producing positive cash flow 20% higher than the sum total of the mortgage payments for a given year. This ratio can flucuate depending on the annual net operating expenses and/or whether the mortgage payment is also adjusted due to changes in the interest rate. However, what is most important is what the DSCR is at the time the loan is being considered. A DSCR of less than 1.0 means the property has negative cash flow and the property owner will have to dip into their personal bank accounts in order to make the monthly mortgage payment. A DSCR of 1.0 means the property is breakiing even.

In most cases lenders require a mimimum DSCR for apartment hard money loan or other commercial real property loans of 1.20. Many times the loans are denied because this minimum DSCR is not met. Also borrowers  mistakenly believe the lenders only consider the actual expenses of the property in determing this ratio. When in fact the lenders take into consideration other potential expense items such as unexpected repairs and maintenance, vacancy rate, reserves for replacement  and off-site management which are not actual expenses included in your operating expense statement . For example, if the borrower defaults on the loan, the lender will be required to hire someone to manage the facility or if the facility looses a tenant = vacncy factor. On the other hand depreciaton expenses are not considered in calculating the net operating expenses because depreciation expenses are non-cash expenditures that do not impact your cash flow negatively.

Following is an example of how a lender calculates DSCR for conventional type commercial  loan:

Lets assume a 10 unit apartment building at $850 per month each, $500,00 loan payable in 15 years at 7%:

Gross Rental income                                     $102,000

Less 5% Vacancy                                          $    5,100

Net Gross Rental Income                              $   96,900

Property Taxes & Insurance                         $   12,000

Repairs & Maintenance                                $     2,000

Replacement Reserves $100 per                 $     1,000

Utiities                                                           $     2,000

Janitorial                                                       $     2,000  

Miscellaneous                                               $     2,000

Off-site Management @5%                           $     5,100

Total Operating Expenses                             $   26,100

Net Operating Expenses                                $   70,800

Loan Amount;      $500,000

Interest Rate                   7%

15  Year Term

Annual Mortgage Payments (Total Debt Service)  $53,930

DSCR = $70,800/$53,930

DSCR = 1.31

What this example means is that the cash flow generated of $70,800 by the property will cover the new annual loan payments of $53,930 by 1.31 times. This is higher than the normal minimum requirements of lenders which range from 1.20 to 1.25.

The above example is for illustration purposes only of the basic methodology applied in detrmining DSCR. Hard money loans DSCR requirements may be a little different in that the term of years are generally 1 to 5 and interest payments only with a balloon payment due at the end of the term. Therefore, an exit strategy must be presented to the lender.

In many instances commercial lenders will offer gobal DSCR. A gobal DSCR is a ratio that combines both personal and property income and expenses. This allows a property with weak cash flow to still qualify for a commercial loan provided the property owner has additional income to add to the property NOI.