I know DSC is a pretty common metric in RE to understand a properties ability to meet it's payments. However, wouldn't it be an incorrect metric since principal payments are paid after paying taxes.
Example, a property has $500k in NOI and $450k in debt service. So DSC is 1.11. However, only interest is paid pre-tax. So lets say interest is about 200k and principal is 250k.
500 - 200 = 300k and then you have to take taxes of lets say 30% off the profits. This gives you about 210k after paying interest and taxes. Now you have to pay the 250k of principal, but if you only have $210k left, you would be short. Do I have this right? Thoughts?
NOI doesn't include non-cash tax write offs like depreciation. So you may be right if there were no other non-cash deductions, but depreciation is required. The front-end of the calculation DSCR (or DCR) includes adding in depreciation expense to the NOI.
This ratio that I got from readyratios.com demonstrates how it works:
DSCR = (Annual Net Income + Interest Expense + Amortization&Depreciation + Other discretionary and non-cash items like non contractual provided by the management)/ (Principal Repayment + Interest Payments + Lease Payments)
Yes I was referring to there being no depreciation. Speaking of which, lets say I have a piece of land and the site is built to suit with an absolute triple NNN lease. Does the landlord get the benefit of depreciation even though the tenant built it?
The depreciation benefit is per IRS rules. It requires depreciation for properties used as investments. So whoever owns the property and is reporting income from the property on their tax returns would get the depreciation deduction. If it were a ground lease with land owned by the land lord and building owned by the tenant then I would assume the tenant gets the depreciation benefit since land doesn't depreciate.
Gotcha, yea we are looking at buying this one property. Its a strong credit tenant with a 20 year lease. It says the tenant is responsible for the entire building, but I guess I will have to check to see the structure. Thanks for your help.
a lot of guys on here are not going to know anything about taxes, because taxes don't exist when you're modeling a building for an LP or REIT or pension fund that doesn't pay income taxes
Income taxes vary depending on ownership structure. So, at a project level, DSCR is still an important metric. I also like to look at debt yield. My firm incorporated debt yield into our models back in 09.
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