A property generates NOI of $95,000 annually and has annual debt service of $72,000. What is the debt coverage ratio?
Correct Answer
B) 1.32
Debt Coverage Ratio = Net Operating Income ÷ Annual Debt Service. $95,000 ÷ $72,000 = 1.32.
Why This Is the Correct Answer
Option B is correct because the Debt Coverage Ratio formula is NOI ÷ Annual Debt Service. Substituting the given values: $95,000 ÷ $72,000 = 1.3194, which rounds to 1.32. This calculation shows the property generates 1.32 times the income needed to cover its debt service. The ratio above 1.0 indicates positive cash flow after debt service payments.
Why the Other Options Are Wrong
Option A: 0.76
Option A (0.76) represents the inverse calculation of Annual Debt Service ÷ NOI ($72,000 ÷ $95,000), which would indicate the property cannot cover its debt obligations.
Option C: 1.24
Option C (1.24) appears to be a miscalculation, possibly from rounding errors or using incorrect figures in the formula.
Option D: 0.81
Option D (0.81) is another inverse-type calculation that would incorrectly suggest the property has insufficient income to cover debt service.
NOI Over Debt = Coverage Spread
Remember 'NOI OVER DEBT' - NOI goes on top (numerator), Debt service goes on bottom (denominator). Think 'How many times does my NOI cover my debt?' The answer should be greater than 1 for positive coverage.
How to use: When you see DCR questions, immediately write the fraction NOI/Debt Service, then plug in the numbers with NOI on top and annual debt service on bottom.
Exam Tip
Always double-check that your DCR result makes logical sense - if it's less than 1.0, the property loses money after debt service, which is typically a red flag for lenders.
Common Mistakes to Avoid
- -Inverting the formula (putting debt service over NOI)
- -Using gross income instead of NOI
- -Forgetting to include all debt service components (principal + interest)
Concept Deep Dive
Analysis
The Debt Coverage Ratio (DCR) is a critical financial metric used by lenders and appraisers to assess a property's ability to service its debt obligations. It measures how many times the property's Net Operating Income can cover the annual debt service payments. A DCR above 1.0 indicates the property generates sufficient income to cover debt payments, while below 1.0 suggests potential cash flow problems. Lenders typically require a minimum DCR of 1.20-1.25 for commercial properties to ensure adequate cash flow cushion.
Background Knowledge
Net Operating Income (NOI) represents the property's annual income after operating expenses but before debt service and taxes. Annual debt service includes both principal and interest payments on all property loans. The DCR is essential for loan underwriting and property valuation analysis.
Real-World Application
Lenders use DCR to qualify borrowers for commercial loans. A property with 1.32 DCR provides a 32% cushion above break-even, making it attractive to lenders. Appraisers reference typical DCR requirements when estimating market-derived capitalization rates using mortgage-equity techniques.
More Math & Stats Questions
What is the area of a triangular lot with a base of 120 feet and a height of 80 feet?
An irregular lot has the following measurements: Side A = 100', Side B = 150', Side C = 120', Side D = 180'. If the lot can be divided into two rectangles (100' × 150' and 120' × 30'), what is the total area?
A property has a potential gross income of $180,000, vacancy and collection loss of 7%, and operating expenses of $65,000. What is the NOI?
A property generates $120,000 in net operating income and is valued at $1,500,000. What is the capitalization rate?
A building has potential gross income of $180,000, vacancy and collection loss of 8%, and operating expenses of $54,000. What is the net operating income?
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