Investor · Suwanee, GA · Member since 2020 · 182 posts · 151 votes
When evaluating a potential real estate investment, both the Debt Service Coverage Ratio (DSCR) and the 50% Rule can be helpful tools. However, they approach financial health from different angles.
The 50% Rule is a quick estimate that suggests operating expenses (excluding mortgage principal and interest) will roughly equal 50% of the property's gross income.
The DSCR is a more precise calculation (Net Operating Income / Total Debt Service) that determines if a property generates enough income to cover its debt obligations.
Deal example:
- Class C middle class neighborhood
- 4bd / 2ba single family house
- ARV: 190k
- Purchase: 105k
- Rehab: 35k
- Market rent: $1,400-1,525
- Section 8: $1,475
- Property manager: 10%
- Taxes: 125 month
- Insurance $1250 yr
- HOA: $55 month
- purchased and rehabbed with all cash. Considering doing a 75% cash out refinance > 30yr 7.45% interest rate
In what situations might the 50% Rule provide a misleading picture of a property's financial health, and when would relying solely on the DSCR potentially overlook important factors?
The 50% rule - in my opinion- is used solely as a quick back of napkin calculation to determine if it is worthwhile to do more investigating of a property.
Though DSCR gives you a better picture of how the property is projected to perform vs debt service, you can't rely solely on one measure to make a purchase decision.
With the numbers you provided above, you will have to ensure you have healthy reserves. Though at 1525/mth it is projected to cashflow a little less than 100/mth -- the numbers do not include what I like to call reality numbers (vacancy loss, maintenance, capex reserves). Just one month of vacancy a year takes away any cashflow you would have.
I would be beneficial to determine if they are other aspects of the property that make it a worthwhile investment (tax, appreciation etc). This goes back to the aspect that you can't rely solely on one metric.
@Obed Calixte how much do you allocate for maintenance and capex? I have found I can lower this number if I rehabbed the property myself before I rent it vs buying a tenant occupied property.
I have a DSCR lender that is willing to do 70% cash out LTV at 7.25% OR 75% cash out LTV at 7.60%. any suggestions on how I should compare these 2 options?
both have 5yr pre pay penalty. I am leaning towards 75%