Which metric helps lenders assess ability to cover debt service during downturn?

• A. Loan-to-value ratio
• B. Debt yield
• C. Debt Service Coverage Ratio
• D. Cash-on-cash return

Answer: (C)

The concept being tested is a measure of whether a property's income is enough to cover its debt payments, especially when the market weakens. The metric that does this best is the debt service coverage ratio. It’s calculated as net operating income divided by annual debt service. A higher number means a bigger cushion between income and debt payments, which is crucial if rents or occupancy drop in a downturn.

Lenders look for a DSCR above a minimum threshold (often around 1.2 to 1.5, depending on risk) so there’s room to absorb decreases in income. Other metrics aren’t as directly tied to the ability to meet debt service in a downturn: loan-to-value compares loan amount to property value, not cash flow; debt yield compares NOI to the loan amount but doesn’t directly show coverage of debt obligations; cash-on-cash return focuses on investor cash flow rather than the property's debt payments.