There are many moving pieces to consider when diving into the world of commercial real estate investment. Investors must research the market, build a strong network, secure a strong investment team, and choose the perfect property. But how will it all be funded? This is where DSCR loans come in.

What is a DSCR loan?

A DSCR loan, or debt service coverage ratio loan, is a type of loan specific to commercial real estate investment. This type of loan calculates how much income your property generates compared to the payments you will owe.

Specifically, the formula to calculate your DSCR is as follows. Annual net operating income + annual debt payments = DSCR. This seems like a simple calculation – and it is – but there are a couple of additional steps required to complete this equation.

First, your annual net operating income must be calculated. To do this, simply subtract your annual operating expenses from your annual revenue. Next, determine your total annual debt payment by adding your principal payments, your interest payments, and your lease payments.

Generally, lenders look for a DSCR of at least 1.2-1.5. If you don’t meet this minimum requirement, some lenders may still be willing to extend a loan but will require you to put up some additional collateral. If your loan is denied, it may be time to go back and look for ways to reduce expenses, and/or increase the profitability of your property.

Benefits of DSCR Loans

DSCR loans are very different from traditional mortgages. In many ways, they can be ideal loan options for first-time or even experienced commercial real estate investors. Here are five of the top advantages of DSCR loans.

1. Your personal finances don’t matter

When it comes to DSCR loans, lenders don’t care about your personal income. Instead, the loan is solely based on your debt service coverage ratio. This means you don’t need to include proof of employment or submit your bank statements or W-2 forms. You don’t need to produce proof of income, and your personal financial information can remain private.

This is ideal not only for those with little or no credit history, but it can also be an asset for people who are self-employed or who have complex tax information.

1. The process is simpler

There’s a lot less paperwork and documentation required to secure a DSCR loan, compared to a traditional mortgage. This means the process, in many ways, is much simpler than that of securing a traditional loan.

Rather than spending time gathering financial information, pay stubs, bank statements, and tax documents, you can spend your time searching for the perfect properties, expanding your portfolio, or developing the properties you already have.

1. Quick approval

Because so much less paperwork is required, the process for securing a DSCR loan is generally quicker and more streamlined than that for a traditional loan. Without the need for tedious background checks and time-consuming employment verification, loans can be approved quickly.

This can be especially helpful in competitive markets, or when pursuing popular or highly desirable properties. DSCR loans are approved much quicker than traditional loans, which means this may give you an advantage over competitors.

1. Lower interest rates

Again, all that really matters when applying for the DSCR loan is the ratio of how much cash flow your property will generate to how much debt is owed. This calculation makes it easy for lenders to separate qualified candidates from the unqualified.

If approved for a DSCR loan, you will likely benefit from lower interest rates compared to other types of loans. This is because DSCR loans are considered lower risk. Lenders can see in black and white that your income will be higher than your debts, and are more able to trust that payments will be made.  

1. Unlimited growth potential

Many loan types require the investor to commit to one property at a time. This is because in many cases, one loan must be paid off in full before another will be granted. This is not the case when it comes to DSCR loans.

Instead, DSCR loans allow you the freedom to develop your commercial real estate investment portfolio however you’d like, on your own schedule, as long as each property has an acceptable DSCR. This is because investors are able to take out multiple loans, concurrently, on multiple properties, as long as they meet the ratio requirements.

Wrap Up

Based solely on the ratio of net income to debt payments, DSCR loans can offer a simpler, more streamlined, and more flexible way to finance commercial real estate investments. Not only do they require less documentation up front, but they can also save money in the form of lower interest rates over time and give investors a time advantage over competitors.