Debt coverage ration (DCR), tax returns, and commerical loans

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I understand that DCRs need to be 1.25 and above for commercial loans, but what source do lenders use to compute those numbers? Tax returns? Just most recent or 2 years worth? Do they ignore depreciation as it appears on the tax return since it's non-cash? Do they take any and all expenses listed on the tax return or just PITI? Do they typically assume a %rent loss for vacancy? I have a friend who told me he had to redo his tax return to get commercial loans.

Thus far we have only gotten residential loans, but going forward given DTI limits and the ten property residential loan limit, we will start to use commercial loans. We filed an extension for 2014 taxes and I'd like to get them done right the first time around if they will be used to determine DCRs for our existing rentals.

@Kimberly H. The answer to your question is it depends on the lender. As the majority of real estate owners do not have audited statements for their holdings it is not uncommon to rely on either management prepared operating statements or tax returns. The debt coverage ratio excludes non cash items . The test measures Net operating income before debt service (principal and interest). It otherwise includes all operating expenses. Whether vacancy/credit is included depends on how the lender decides that it wants to define NOI in the loan documents and whether that definition includes a percentage for vacancy /credit. I have seen it like that and I have seen it where it s excluded. I have never heard of someone having to redo their tax return. When first applying for a loan the lender may want 2 -3 years of historical financials to review. This helps them to assess any potential aberrations in operating performance such as repair and maintenance items that may not be recurring expenses. For the purpose of doing a projection of future performance the lender will account for vacancy/credit Best of luck.


@Michael Leffelholz

Thanks, I know things depend on the lender, but what % have you seen assumed for vacancy or any other deductions?

As a general rule of thumb, most lenders will use 75% occupancy, unless your actual Financials show less.  Debt Service Coverage Ratio's are based on whatever overlays a particular lender puts in place.  1.25 - 1.75/2.0 is not uncommon.  A lot depends on the depth of the borrower and the details of the transaction.  There really is no hard and fast "guideline."

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