NOI, Cap Rate and DSCR: The Three Numbers Behind Commercial Loans
Commercial lenders size loans with three numbers. Understand how they connect and you can see your loan amount before the lender does.
Short answer
Net operating income is rent minus vacancy and operating expenses. Divide NOI by a market cap rate to estimate value. Lenders then size the loan by both loan-to-value and DSCR, which is NOI divided by annual debt service, and lend the smaller of the two. On many deals, DSCR is the limit.
Key points
- NOI = income after vacancy and operating expenses.
- Value ≈ NOI ÷ cap rate.
- The loan is the smaller of the LTV and DSCR limits.
Net operating income
Start with gross rent, subtract vacancy and credit loss, then operating expenses: taxes, insurance, management, repairs, utilities and reserves. What's left is NOI. Debt service doesn't come out of NOI; it's what NOI has to cover.
Cap rate and value
A cap rate is NOI divided by value, set by what similar properties trade for. Rearranged, value is NOI divided by the cap rate, so a lower cap rate means a higher value for the same income.
DSCR and loan size
Lenders test the loan two ways and use the smaller result: a maximum loan-to-value and a minimum DSCR, commonly around 1.20 to 1.25 on commercial loans.
Deal sheet: Small apartment building, illustrative
| Amount | |
|---|---|
| Net operating income | $100,000 |
| Value at a 6.25% cap rate | $1,600,000 |
| Loan at 65% loan-to-value | $1,040,000 |
| Annual payment at 7.25%, 30-year | $85,136 |
| DSCR at that loan size | 1.17 |
| Loan sized to a 1.25 DSCR | $977,000 |
Here the value supports $1,040,000, but at that size the DSCR is only 1.17. Sizing to a 1.25 DSCR caps the loan near $977,000, so DSCR is the binding limit.
Looking at a 5+ unit or mixed-use deal? Send the rent roll and operating statements and we'll take a look. Review my deal
How to improve the numbers
Raise NOI with rent increases or expense savings; see value-add multifamily. Or bring more equity so the loan fits the coverage test.
Frequently asked questions
How do you calculate NOI?
Start with gross rental income, subtract vacancy and credit loss, then subtract operating expenses such as taxes, insurance, management and repairs. Debt service isn't included.
How does cap rate affect property value?
Value is roughly NOI divided by the cap rate, so a lower cap rate produces a higher value for the same income.
What DSCR do commercial lenders require?
Many look for around 1.20 to 1.25 or higher, though requirements vary by lender, property type and program.
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