DSCR and interest cover in development-to-investment lending

Build the numerator before applying a ratio

A property's net operating income usually excludes debt financing, but lender definitions vary on reserves, management fees, capital expenditure and other adjustments. Start with a bridge from rental and other income through vacancy, collection losses and operating expenses to the numerator accepted for the loan.

The OCC handbook discusses income-producing property and debt-service capacity. Fannie Mae's underwriting form separates rental concessions, bad debt and operating expenses. These sources show why an unexplained rent total is not an adequate numerator; they do not establish the terms of your facility.

Sources: Office of the Comptroller of the Currency: Commercial Real Estate Lending, version 2.0; Fannie Mae: Multifamily Underwriting Standards

Compare DSCR with interest cover

An invented stabilised building produces 1.2 million of annual income after the operating deductions assumed here. Interest is 0.6 million and scheduled principal amortisation is 0.2 million. Debt service is 0.8 million. DSCR is 1.50 times, while interest cover is 2.00 times.

If the same debt is interest-only for a year, both ratios would be 2.00 times on the same numerator. That does not make the long-term loan equally affordable: scheduled principal payments in later periods reduce headroom.

Measure the lease-up period honestly

At 0.72 million of income with unchanged 0.8 million debt service, DSCR falls to 0.90 times and the cash shortfall is 80,000. A full-year stabilised forecast cannot pay that current-period shortfall. Build a monthly lease-up schedule and state whether the agreement tests actual trailing income, forward income, annualised recent income or another measure.

Avoid multiplying one unusually strong month by twelve and calling the result stabilised NOI. Seasonality, concessions and one-off receipts can distort that shortcut. Show actual cash available separately from any covenant-defined annualisation.

Translate the covenant into a cash threshold

Assume, only for this example, a minimum DSCR of 1.25 times. Required income is 1.25 × 0.8 = 1.0 million. The 1.2 million base case therefore has 0.2 million of income headroom. A 20% decline in income to 0.96 million produces 1.20 times cover and fails that assumed threshold.

If interest rises while principal amortisation remains fixed, both the ratio and threshold income change. Recompute them from the new payment schedule. An equity cash injection may fund debt service but does not necessarily cure an income covenant unless the agreement expressly allows that treatment.

Report the breach date and the funding consequence

For each test date, display the numerator, interest, principal, ratio, minimum threshold and surplus or deficiency. Separately show the cash shortfall, reserve use and sponsor support. A covenant breach may restrict distributions or trigger other rights even when there is enough cash to make the next payment.

Read the lender's treatment of balloon repayments, cash sweeps and reserve releases. Do not insert a maturity balloon into an ordinary operating DSCR definition, or omit it from the repayment funding plan, without explaining the distinction.