Debt Service Coverage Ratio and HUD 223(f) Financing
Debt Service Coverage Ratio, or DSCR, is one of the most important metrics that lenders examine when determining whether to give a HUD 223f loan to a potential borrower. DSCR is designed to compare a property's annual cash flow and its annual debt service in order to assess the likelihood that a borrower will pay his or her debts on time, and avoid a mortgage default.
How to Calculate Debt Service Coverage Ratio
Debt Service Coverage Ratio can be calculated using the formula provided below:
DSCR = Net Operating Income / Annual Debt Service
For example, if a property had a net operating income (NOI) of $1 million, and an annual debt service of $850,000, the DSCR would be:
$1 million / $850,000 = 1.17x
DSCR Requirements for HUD 223(f) Loans
HUD 223(f) loans have a minimum 1.18x DSCR requirement for market-rate properties. In the example above, the property would qualify (albeit narrowly) for a HUD 223(f) loan, at least in terms of DSCR. If the property was an affordable property (1.15x min. DSCR), or a rental assisted property (1.11x min. DSCR), it would have a little more leeway.
It's important to appreciate that a 1.0x DSCR simply means that an investor/developer is breaking even. That's why lenders like to see a certain margin of safety to ensure that unexpected events (i.e. higher than usual vacancy, natural disasters) are less likely to prevent a borrower from paying their mortgage.
In many cases, multifamily lenders may be more flexible with DSCR requirements if a property's loan-to-value ratio (LTV) is lower. However, since the HUD 223f loan is government-insured, the DSCR still cannot go below the minimum amount for that property type.
