Virtually every self-storage investor purchases their property using debt. Investors use leverage to limit their upfront expenses and finance the remaining costs with a loan.
When you apply for a loan, the lender will evaluate your debt service coverage ratio (DSCR) to determine the potential risk of working with you.
What Is Debt Service Coverage Ratio?
The debt service coverage ratio compares your amount of cash flow to your debt obligation. It’s a metric that lenders and investors use to determine whether a property’s generated income is enough to repay a loan.
Lenders use DSCR to decide your loan eligibility, the amount of your loan and the terms. Typically, the larger the loan you’re applying for and the longer the term, the more importance lenders will place on your DSCR. Lenders want to ensure they’ll see a return on their investment and avoid dealing with borrowers who default.
How to Calculate DSCR for Self-Storage
To calculate the DSCR for your self-storage facility, you divide your net operating income (NOI) by your debt obligations:
- DSCR = NOI / Debt obligations
NOI is your facility’s total income minus your operating expenses and vacancy losses. Debt obligation is typically the principal and interest payment owed each month, though some lenders might include taxes and insurance.
For example, if your facility has an NOI of $2 million and debt obligations of $1 million, your DSCR would be 2.
What Is a Good DSCR for Self-Storage Properties?
Generally speaking, here’s how you can interpret your DSCR:
- DSCR < 1: You have a negative cash flow and you don’t have enough income to service all your debt.
- DSCR = 1: You have exactly enough cash flow to service your debt, with no financial cushion.
- DSCR > 1: You have a positive cash flow. The higher above 1 your DSCR, the more money you have to repay your debt.
Every lender has different DSCR requirements. For self-storage facilities, lenders typically like to see a DSCR of at least 1.25. Banks typically won’t offer loans if your DSCR is at 1 because they don’t feel they have the necessary protection should anything go wrong.
If there are factors that will immediately affect your DSCR after purchase, be sure to include them in your loan application. For example, immediate cost cuts or revenue increases could improve your DSCR.
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