What does the Debt Service Coverage Ratio (DSCR) measure?

The Debt Service Coverage Ratio (DSCR) is a key financial metric used to assess a borrower's ability to cover its debt obligations, specifically in the context of real estate financing. The ratio compares an entity's operating income (often represented by net operating income, or NOI) to its total debt service obligations (the total amount of principal and interest payments due over a specified period).

When the DSCR is greater than 1, it indicates that the entity generates more income than needed to cover its debt payments, suggesting a lower risk of default. A DSCR of less than 1 would imply that the borrower does not generate enough income to meet their debt obligations, pointing to a higher risk of financial distress.

This metric is critical for lenders, as it helps them evaluate the financial health of a property or business and the likelihood that it can generate sufficient income to repay the borrowed funds. Thus, focusing on the ability to cover debt payments highlights the functional aspect of assessing financial stability and risk management in real estate finance.