The #1 Metric To Look At To Prevent Cash Calls

Debt is the number 1 killer of commercial real estate deals and this metric is something you really need to understand.

Your DSCR is your debt service coverage ratio. This is the ratio of cash flow a property needs to have in order to support the loan.

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Most banks will require at least a 1.2% DSCR, meaning if your annual mortgage payments are $1,000,000, you’ll need to be projecting $1.2M in cash flow so you have enough to pay the debt plus some extra room.

All loans that use the income from the property as mortgage payments will have some type of DSCR requirement and having a strong DSCR will help prevent some of the worst case scenarios for a passive investor: Cash calls and forced sales.

If a property falls below its DSCR requirement, many banks will require additional collateral to keep the loan secure, typically in the form of increased cash. If the property does not have this cash on hand operators can be forced to cash call their investors for this extra capital.

If the bank is more strict in their DSCR requirements, they can choose to call the loan all together and force a sale of the property.

A property with too low of a DSCR means there isn’t projecting much free cash flow, which in today’s environment is more important than ever.

A strong DSCR also means there is less of a chance to see a cash call. If a property has strong cash flow there typically isn’t a reason for investors to have to put up extra cash.

If you have a property that is projecting a 1.5+ DSCR you’ll typically be in good shape, with the absolute minimum usually around 1.2.

Before you invest in an offering pay attention to the DSCR of the deal so you can gauge how risky the property may be in regards to cash calls.

As a bonus piece of due diligence, you should verify the DSCR and also how much monthly expenses they will have saved up for the deal. Most operators will raise a certain amount of additional cash up front, essentially like a savings account for the property.

If I see a property with a strong DSCR and that has enough reserves saved up to pay for 3+ months of expenses and debt service if they collect $0 in those months, I tend to feel pretty good about the deal.