Debt service coverage ratio

Net operating income divided by the annual mortgage payments. Below 1.00 the asset does not pay for its own borrowing.

Example

Income of 12,792 against annual debt service of 17,396.14 is 0.7353, a shortfall of 4,604.14 a year from the owner elsewhere.

Important

It does not make a property a bad investment, but it converts a passive holding into a standing claim on other income for years. Compute it at the loan actually intended, before anything attractive.

Related terms

• Cash-on-cash return — A year of cash flow after financing, divided by the cash actually invested - deposit plus purchase costs - rather than by the price of the asset.
• Loan to value — The outstanding loan divided by the current value of the asset securing it.
• Leverage — Investing with borrowed money so that you control more of an asset than your own capital would buy. Gains and losses are both multiplied by the same factor.

Lessons that explain it

• Appraising one loan: what backs it, how thin the cushion is, and who collects — Evaluating a loan means asking how the borrower repays, what happens if they cannot, how far collateral could fall before you lose money, and how reliable the lender or platform is at recovery. (13 min)
• Appraising one property: the numbers, the condition, the tenant and the exit — Seven checks on one specific building. The two that decide most outcomes - the deduction list and whether the income covers the borrowing - are the two that never appear in a listing. (14 min)
• The return is discretionary earnings, financed with debt the business itself has to service — Seller's discretionary earnings is a reconstructed number built from add-backs, and almost every small-business purchase is financed with debt the business's own cash flow is expected to repay - which makes the add-back schedule the single most consequential piece of arithmetic in the deal. (12 min)
• Appraising one business: verify the earnings before you price anything else — Seven checks on one specific listing, in an order that puts verifying the earnings ahead of everything the earnings are used to justify - because every other number in the deal is built on top of a figure the seller had every reason to shape. (13 min)

All 578 terms in the Investing glossary