Distressed Property Workouts means understanding DSCR

The term "distressed property" is one of the hottest words used in the real estate industry.  Almost everyone knows someone whose commercial or residential property is distressed.  Banks are in a jam to work these properties out.  If you know what a distressed property is, then you can help your client, either the bank or the borrower, stand themselves up again.

Banks calculate a DSCR (Debt Service Coverage Ratio) when lending on real estate.  This formula is used to determine a mortgaged property's ability to cover monthly payments.  The DSCR is the monthly NOI (Net Operating Income) of the property divided by the Monthly Debt Service.  For example, if the commercial property receives $50,000 in NOI every month and the Monthly Debt Service will be $35,000 to the bank.  The DSCR would be 1.42, meaning that the property would generate more than enough cashflow to service the debt.  If the DSCR is below 1.0 then this means the property is not generating enough cashflow to service the debt.  Most banks are looking to lend on properties that have a DSCR of at least 1.3.  This gives the bank assurance that if anything goes awry there will still be a cushion from the income to at least cover their debt service.

While the property may have had a stellar DSCR when the bank lent them money on the property, when the DSCR falls below 1.0, meaning the property is not generating enough income to pay the debt service, then the property is distressed.

When this happens there are many options for a lender or borrower to choose which we will discuss in further blogs.  Buy by understanding what DSCR is will give you a fundamental starting place as where the property is and where it needs to get to again.