Many investors find that while managing a single-family home is easier, multi-family investment properties offer a higher return on investment (ROI). With increased tenants, multi-family homes can better protect the property from market conditions. However, investing in multi-family properties can be more involved. With an increased number of tenants comes an increased amount of capital needed to maintain the properties and increased regulations.
When looking for multi-family home investment opportunities, analyzing the Debt Coverage Ratio (DCR) is a useful tool to determine whether the property is financially viable. Below are a few elements to keep in mind when looking to invest in multifamily rental properties.
DCR is often calculated by finding the net operating income(NOI) of the property. For example, in this scenario, it's $850,000 per year with a combined annual debt service of $680,000. The formula looks something like this:
$850,000/$680,000 = 1.25x DCR
Typically a DCR result of over 1 is considered profitable. Anything less, and it’s considered a loss.
While calculating for DCR isn’t too complicated, it's incredibly important to calculate the NOI as accurately as possible. If it's not calculated correctly, it may lead to inaccurate results, which can result in you losing money.
Stability Cash Flow is an important indicator of the ability to meet obligations such as loan payments, interest, bills, and maintenance fees. Using the DRC, you can measure the property's ability to generate adequate capital to cover your debt obligations. You can then analyze the previous projected rental income, vacancy rates, costs of operations, and future rent increases. This can help you to determine an estimate of what the property's potential resources will be. If the DCR is high, this property is considered desirable because it can generate enough income to cover its debt obligations. Low DCR, on the other hand, is considered far less enticing as it may require further investment.
Most lenders will have a specific DCR/DSCR requirement before approving loans. Knowing these requirements is critical when applying for a loan. A lender may use a form of the DCR to determine if you will be eligible for the loan. They may take into account both your debt and income. Naturally, more personal income and less personal debt will increase the likelihood of approval. Large personal debts, including mortgage, credit card debt, or student loans, can be detrimental to receiving a loan. A higher DCR also indicates to the lender there is a lower financial risk. Which greatly improved the likelihood of a favorable loan.
The market conditions can play a meaningful role in how successful a multi-family investment property is. Items such as rental demand, vacancy rates, and potential rental growth in the target market can help you determine the property's potential income. This can have a great effect on the DCR.
In order to make an informed investment decision, you need to best align your investment strategy with the property's DCR goals and long-term program.
Understanding how to calculate DCR when searching for a multi-family investment property can be difficult for first-time and experienced investors. If you need help calculating the DCR of an investment property in Long Beach, CA or need a property management company to help you manage a rental property you own, we invite you to call us today at (562) 888-0247 or fill out our
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