Most lenders look for a BER of 85% or less. If occupancy rates in a particular market are exceptionally low (meaning that the certainty of your revenue stream is especially dicey), lenders may require a BER that is several percentage points less than the average occupancy rate.

Break-Even Ratio = (Debt Service + Operating Expenses) / Gross Operating Income

You should know about the break-even ratio (BER, also sometimes called the default ratio) because it is a benchmark often used by lenders when underwriting commercial mortgages. Its purpose is to estimate how vulnerable a property is to defaulting on its debt should rental income decline. There is an old saying that when your outgo exceeds your inc

Most lenders look for a DCR of at least 1.20, often even more. A property with a 1.20 DCR has income before debt service that is 1.20 times as much as the debt service—in other words, the property generates 20% more net income than it needs to make its mortgage payments. You can be certain that the lender will examine the property’s DCR carefully.

Debt coverage ratio (DCR) is the ratio between the property’s net operating income (NOI) for the year and the annual debt service (ADS). If your NOI and ADS are exactly the same (say $10,000), then the ratio is 10,000 divided by 10,000, or exactly 1.00. A DCR of 1.00 implies that you have exactly enough net income from the property to make your mor

The cash-on-cash return (also called the equity dividend rate) is the ratio between the property’s cash flow in a particular year (usually before taxes) and the amount of the initial capital investment. It is expressed as a percentage.

You’re more likely to encounter surprise expenses than surprise income, so be realistic when forecasting the cash flow from a property you plan to buy. Do you expect the cash flow to be small or nonexistent? If so, the reality may well prove to be that you’ll actually have a negative cash flow. This means you would need to inject your own personal

Capital additions are additions having a useful life of more than one year or improvements that are likely to prolong the life of the property. A capital addition is different from a repair, which maintains rather than increases the life of a property.

Top-down calculation: Net Operating Income less Mortgage Interest less Depreciation, Real Property less Depreciation, Capital Additions less Amortization, Points and Closing Costs plus Interest Earned = Taxable Income