How do you estimate DSCR with smoothed CapEx/repairs assumptions?

Question

Hello all. I recently learned that lenders underwrite DSCR based on actual expenses incurred in a given year, not on “smoothed” CapEx assumptions used in pro formas.

For example, in my underwriting I may assume CapEx averages at 8% of rent annually. In reality, however, one year could include a $10k roof replacement while the following year could have near-zero major repairs. This makes it difficult to know which specific year will be the one evaluated against a 1.25 DSCR requirement.

To account for this, I’ve been treating a smoothed 1.15 DSCR as effectively equivalent to a 1.25 DSCR in years without major CapEx events, since the actual cash flow in those years would be materially higher.

Is this a reasonable way to think about DSCR risk and lender underwriting, or is this logic off-base?

Thanks in advance.

Bo Smith · Answer

I smooth CapEx over 5-7 years using property age + condition. New construction might be $500/door/year, older stuff $1200+. For DSCR calcs, I add 20% buffer to my smoothed number because lenders hate surprises. Are you underwriting for portfolio lending or selling to investors?

Erik Estrada · Answer

Okay yes then that is correct. It is calculated based on Market Rent or Actual Rent as long as the variance is not over 120% of Market Rent Value. The monthly expense will be Principal, Interest, Taxes, Insurance, and HOA. No other expenses.

The property value will be based on the sales comparison approach on a 1-4 unit residential property.

You also don't need the property tenant occupied to close on the loan.

Erik Estrada · Answer

I am assuming this post is geared towards 5+ Unit Multifamily and Commercial Buildings?

Jonathan Warner · Answer

@Erik Estrada

It's for single family residential. Doug Smith has already corrected me on SFR residential DSCR underwriting.

Doug Smith · Answer

Former Bank Commercial Lender reformed into a Mortgage Lender here. Commercial Bankers always considered DSCR to = Net Operating Income / All Expenses and usually required 1.25X or higher. The new DSCR product for Investors is much simpler. It is simply DSCR = Market Rent / PITI + HOA...that's it...and they are usually looking for 1.0X or more (with some going lower). The way a commercial bank calculates DSCR is apples to oranges as to how investor DSCR loans are calculated. If you're looking at a Single-Family through a residential 4-unit, then using CapEx and other metrics is not used. If your'e looking at a apartment buildings, medical centers, or other true commercial loans, then the calculation is more along the lines of what you're talking about. I hope that helps.

Doug Smith · Answer

They are not changes. That's how it's always been...at least since I started 35 years ago. To a commercial lender since I started DSCR was a more complex calculation for commercial loans. When hedge funds started lending on single family rentals, they took the name "DSCR" and changed what it meant for more basic rental properties. The "real" and more customary way DSCR is calculated is what commercial banks/lenders use on true commercial loans. The overly-simplified DSCR version has only come into existence in the last handful of years for a mass-marketed single-family investor product. It's not a "change" as much as it is a warping of what the DSCR calculation always was for us commercial lenders. Happy to discuss further if you want.

Jonathan Warner · Answer

@Doug Smith Wow I didn't know that. When did these changes occur?

I'm not mistaken, then that makes residential investor DSCR thresholds much easier to achieve, no?

How do you estimate DSCR with smoothed CapEx/repairs assumptions?

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