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Debt Coverage
Ratio |
| The debt coverage ratio expresses the
relationship between net operating income
and debt service, e.g., principal and
interest payments, for an income-producing
property. |
| |
| Application Lenders use this ratio to
assess the ability of net operating income
derived from an investment property to meet
the debt service for that property. The debt
coverage ratio is frequently applied when
lenders are analyzing investment property
for mortgage loan purposes. |
| |
| Debt Coverage
Ratio =
Net Operating Income
÷ Annual Debt Service |
| |
| This ratio is viewed as
a measure of risk associated with mortgage
applications involving commercial
properties. Generally, when the DCR moves
above 1, lender risk decreases and as it
sinks below 1, risk increases. |
| |
|
Example of Debt Coverage Ratio |
| An investor
is attempting to secure a mortgage for a
commercial building that realizes a net
operating income of $43,292. The annual debt
service (principal and interest payments),
for the mortgage is $38,792. Lender Inc.
requires a debt coverage ratio not less than
1.10. |
| |
| Debt Coverage Ratio =
$43,292 ÷ $38,792 =
1.1160 or 1.12 (rounded) |
| |
| Therefore,
Investor’s
application meets the lender’s criteria. |
| |
|
Debt Ratio
|
| One
of several commonly used financial ratios
based on data found on the balance sheet,
profit and loss statement, or a combination
of the two. The simplest example is the
ratio of total liabilities to total assets
that measures the proportion of assets
financed by borrowings. |
| |
| When the debt ratio is
0.50 (50%) or higher, creditors have a
larger investment in the firm than the
owners. The debt ratio may range in value
from 0 for a company with no debt to 1.0 for
a firm financed entirely by debt. Creditors
typically prefer a lower debt ratio, given
the cushion of safety provided by the
owner’s investment. |
| |
|
Example of Debt Ratio |
| If total liabilities for
ABC Realty Inc. are $238,540 and total
assets are $717,440, the debt ratio is: |
| |
| Debt Ratio = Total
Liabilities ÷ Total Assets = $238,540 ÷
717,440 = 0.33 |
| |
|
Debt to Net Worth Ratio |
| A modified measure that
determines average debt to worth and can be
an indication of excessive debt. The debt to
net worth ratio formula is: |
| |
| (Total Debt -
Commissions Payable) |
| Tangible Net
Worth |
| |
| This ratio is probably
better suited to real estate brokerage
analysis given the significant role that
commissions payable to salespeople plays in
financial matters. |
