Debt Service Coverage Ratio
The debt service coverage ratio is a ratio that is related to the revenue generating property. This is the measure of ability of the property to generate so many revenues that will generate enough cash to pay all the mortgage payments related to that property. If the debt service ratio is positive that means the cash generated by the revenues of the property is enough to cover all the offset loan payments. On the other hand a negative debt service ratio indicates that the owner has to accumulate extra cash other than the revenue generated by the property to pay all the loan payments.
It is desirable to have a very high debt service coverage ratio as it gives the owner of the property a proper cushion for paying the mortgages and loans. With the help of debt service coverage ratio the owner can also pay unexpected or expected expenses related to the property of the owner.
The formula of debt service coverage ratio can be shown as under:-
The Net operating income is divided by the annual loan payments related to the property in question
Debt Service Coverage Ratio = Net Annual Operating Income/ Total Annual Loan Payments
In some cases a negative debt service ratio can be occurred that shows the property is transitioning to the new tenants and it is not generating sufficient cash at the beginning of the period but is going to fulfill its loan payment by the end of the term by generating sufficient cash.