“I’m a small-time real estate investor. I have a couple of rental condos in Mira Mesa and North Park, but I’d like to trade into an apartment building. I’ve been talking with people and asking a lot of questions. There’s a term I’ve heard called debt coverage ratio. What is that?”
***ANSWER:
You’re getting into some moderately complex stuff.
When you buy a house, the bank looks at YOUR ability to pay the mortgage.
When you buy a commercial rental property, the bank looks at the PROPERTY’s ability to pay the mortgage, based on rents and expenses.
A debt coverage ratio is the property’s net operating income or NOI (annual income minus expenses, not including mortgage) divided by the debt service (total annual mortgage payments):
NOI/Debt Service = debt coverage ratio.
A property with rents of $200,000 per year and expenses of $70,000 per year has an NOI of $130,000. If it has a debt service of $100,000, then:
$130,000/$100,000 = 1.3 debt coverage ratio
Banks are commonly looking for about a 1.3 debt coverage ratio, meaning they want your net income to exceed the loan payment by 30%. To do that in San Diego, you need to put a whopping amount down!
I know that’s complex stuff for many people. If you have more questions, contact me…
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