How do you calculate the debt coverage ratio (DCR)?

The debt coverage ratio (DCR) is calculated by dividing the annual net operating income (NOI) by the annual debt service. This key financial metric indicates a property's ability to generate enough income to cover its debt obligations. A higher DCR means that a property is generating sufficient income compared to its debt payments, suggesting a lower risk for lenders.

In the context of the real estate and financial analysis, using annual NOI—essentially the income generated from the property after operating expenses but before debt service—is crucial. By taking that income and dividing it by the total annual debt service, which includes both principal and interest payments, the DCR provides a clear picture of financial stability and operational effectiveness.

This formula is essential for both investors and lenders since a DCR of less than 1 indicates that a property may not generate enough income to cover its debt, which can raise red flags for financing and investment strategies. Thus, understanding how to calculate this ratio plays an important role in property valuation and investment analysis.