Understanding Cap Rates and DSC

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2 questions
Posted by: Bill Wilson Jun 22 2004, 02:43 PM
1. What is a cap rate and could you give me an example of how to calculate loan to value using a cap rate.

2. When calculating DSC should you use the figure from the current period or the prior period?

Thanks in advance
Posted by: The Fox Jun 22 2004, 03:02 PM
1: The cap rate is simply NOI divided by value. Capitalization Rates has a good discussion of cap rates in REI. I don’t know if there’s a way to use cap rate only to determine LTV, since it’s independent of financing. If you know the cap rate of a potential investment however, you most likely know the value, which makes it easy to determine an LTV.

2: We calculate DSC over 3 years of data whenever possible. The most current figure is most relevant unless it isn’t (due to an extrordinary event, etc)

Hope that helps. If your question isn’t answered, straighen me out, or maybe LoanUniverse will shed some light on what I missed.
Posted by: loanuniverse Jun 23 2004, 08:31 AM

Fox is right in his description of cap rate. As a prospective real estate investor you can compare different properties based on the “Net Operating Income” of each property. Lets say that you have the choice of buying the following:

Property A ) $150,000 in rental income – $85,000 in operating expenses – $600,000 purchase price.

Then you have

Property B ) $140,000 in rental income – $65,000 in operating expenses – $550,000 purchase price

Then you can pretty much use the Cap rate for comparison NOI / Value = Cap Rate

Property A ) $65,000 / $600,000 = 10.8%
Property B ) $75,000 / $550,000 = 13.6%

As you can see property B ) is the better opportunity since the assets are essentially making more money per dollar than property A )


While it is good to use three years of data whenever possible. Unless the deal is substantially larger than a million dollars or I am looking at an owner occupied deal that is going to be repaid with the cash flow from operations of the company, I base my DSC on last years financials as well as an update with the latest information.

For income producing properties this means a rent roll and copies of the leases to support revenue as well as a complete accounting of expenses.

You really need to put more emphasis in the current information, but you can’t lose sight of the historical performance. Take a look at the spreadsheet that is linked from this page to see what I mean.

Sensitivity Analysis
Author: Commercial Loan Underwriter