So you’ve heard about DSCR (Debt Service Coverage Ratio) loans and are interested in using one to fund your next real estate project in the UK. That’s great! DSCR loans can provide more flexible underwriting compared to traditional commercial real estate loans.
But maybe your current DSCR isn’t high enough yet to get the loan amount you need. Not to worry! There are ways you can improve your DSCR over time to increase your borrowing capacity.
What Exactly Is DSCR And Why Does It Matter?
DSCR measures your ability to cover your debt obligations based on the property’s cash flow. Essentially, it compares your property’s net operating income to your annual debt payments.
The higher your DSCR, the easier it is for you to qualify for more financing.
Lenders use DSCR to determine the maximum loan amount you can qualify for. Typically they look for a minimum DSCR of 1.20 or higher.
The reason DSCR is so important is that it shows lenders you can manage larger loan payments. A higher DSCR gives them more confidence you’ll be able to repay the loan as agreed.
For property owners and real estate investors, improving your DSCR opens up more financing options to grow your portfolio.
How Is DSCR Calculated?
The DSCR formula is straightforward:
DSCR = Net Operating Income / Annual Debt Service
- Net Operating Income (NOI): Your rental income minus all operating expenses and reserves.
- Annual Debt Service: The total loan payments due each year (principal + interest).
Total Rental Income: £100,000
Operating Expenses: £40,000
NOI = £100,000 – £40,000 = £60,000
Annual Loan Payment: £30,000
DSCR = £60,000 / £30,000 = 2.0
In this case, the £60,000 NOI covers the £30,000 annual debt payment two times over (DSCR of 2.0). That’s considered an excellent DSCR.
What’s Considered A ‘Good’ DSCR?
Most lenders look for a minimum DSCR of 1.20 to 1.25 for approval. But the higher your DSCR, the more financing options you’ll have access to.
Here are general DSCR benchmarks:
- Below 1.0 – Highly risky, unlikely to qualify
- 1.00 to 1.10 – Tighter lending standards
- 1.15 to 1.25 – Minimum for conventional financing
- 1.25 to 1.50 – Qualifies for most loans
- Above 1.50 – Preferred borrower range
A higher DSCR above 1.50 gives you the most leeway with lenders and allows you to qualify for larger loans. So taking steps to improve your DSCR over time can really pay off.
Helpful Tips To Increase Your DSCR
Now let’s review some practical tips to boost your net operating income and decrease your debt obligations. Combined, these strategies can strengthen your DSCR profile over time.
Increase Net Operating Income
Your NOI forms the foundation of DSCR. Focus on increasing revenue streams while reducing operating expenses.
If below market rates, consider increasing rents per your lease agreements. Spread increases over several years to ease tenant impact.
Charge Fees for Amenities
Offer new amenities like covered parking, storage, or laundry and charge fees. This creates incremental revenue.
Reduce Operating Expenses
Review all utility, maintenance, staffing, and vendor contracts for potential savings. Find ways to cut costs without sacrificing quality.
Minimize unit vacancies. Any unrented space represents lost potential revenue.
Refinance/Pay Down Existing Debt
Reducing your current debt payments directly improves DSCR.
Refinance at Lower Interest Rate
If interest rates have fallen, refinance existing loans to lower your payment. This immediately increases DSCR.
Pay Extra Toward Loan Principal
Making an extra principal payment reduces your overall interest costs and shortens the loan term.
Pay Off Loans Early
If possible, paying off a loan completely frees up cash flow and eliminates a debt payment from your DSCR calculation.
Optimizing operations can uncover new revenue opportunities and savings.
Evaluate all systems and processes. Identify redundancies or bottlenecks impacting productivity. Streamline wherever possible.
Implement technology to automate tasks and provide analytics into financial performance. This saves on labor costs.
Offer Additional Services
Consider providing additional services like package handling, bike storage, dog walking, etc. for added fees.
Renegotiate Vendor Contracts
Use your growing portfolio to negotiate better rates with vendors, contractors, and property managers.
Make Capital Improvements
Strategic investments in upgrades or renovations can allow you to increase rents and property values.
Updated kitchens and baths help justify higher rents and tenant retention.
Construct an outdoor lounge, dog park, pool, or gardens to command top rents.
Smart Home Technology
Install smart thermostats, lighting, and locks to attract high-paying tenants.
Energy Efficient Upgrades
New windows, insulation, HVAC can lower expenses and environmental impact.
Acquire New Properties
Adding profitable properties to your portfolio grows your overall net operating income.
Buy and Improve
Seek out distressed or dated properties priced below market. Renovate and increase rents.
Develop New Properties
Construct new units on existing land or purchase land for ground-up development.
Sell Underperforming Assets
Liquidate any properties dragging down your overall performance. Reinvest net proceeds into better assets.
When To Consult A Financial Advisor
Improving your DSCR takes time, effort, and careful financial management.
For in-depth guidance, connect with a commercial real estate advisor or accountant. Share your DSCR goals and discuss ways to optimize your property finances.
Here are signs it’s time to seek professional advice:
- Unsure where to start to improve DSCR
- Lacking proper financial systems and processes
- Have limited real estate/finance experience
- Looking to grow portfolio significantly
- Exploring creative ways to boost NOI
- Weighing refinancing vs. new purchase decisions
The right advisor will review your overall situation and create a tailored plan to strengthen your DSCR. This can help you qualify for the ideal loan amounts to scale your rental property investments.
As you’ve learned, your Debt Service Coverage Ratio is key to securing favorable UK commercial real estate loans.
By consistently taking steps to increase your net operating income and reduce debt obligations, you can strengthen your DSCR profile over time.
Focus on raising rents, minimizing expenses, paying down debt, and improving operations.
With an optimized DSCR, you’ll have the borrowing capacity to continue growing your rental property portfolio.
Use this comprehensive guide as a roadmap to boost your DSCR. And don’t hesitate to consult a financial advisor for expert guidance tailored to your unique situation and goals.
Here’s to funding your next real estate investment! Your improved DSCR will provide the financing capacity you need to keep your portfolio thriving.