DCR And Owner Occupied Duplex....
Howdy All! This is my first post, and I have already learned quite a bit from this forum.
My question is this. I have created a spreadsheet to determine the debt coverage ratio of a potential property. I have read the advice of having a DCR of 1.25 or better for profitability. My question is does this hold true for a situation where I will be living in the property as well? I am trying to find a place that has two or three units, one of which I will live in. It seems to me that the formula should change to reflect the fact that I am incurring a living expense, but I am not sure how to do so.
Thank you very much.
Dave
Absolutly Not!
If you're making $700 less from the unit than you would if you had a tenant in there, it's obviously going to be $700 harder to pay the mortgage each month.
DCR = NOI/(yearly debt service)
Obviously, living in one unit will lower your net operating income. (FYI NOI=income-expenses. Do not include your mortgage payment in your expenses)
Some people like to use DSCR to estimate profitablity. In my mind it's just as easy to calculate cash flow. DSCR more than anything is for lenders. In my opinion you need at least 1.5 to break even.
Also, most lenders will add 75% of the income of a property to your income when they're figuring out your ratios.
Hope this helps
Quote:
On 2003-07-11 14:48, hibby76 wrote:
Absolutly Not!
If you're making $700 less from the unit than you would if you had a tenant in there, it's obviously going to be $700 harder to pay the mortgage each month.
DCR = NOI/(yearly debt service)
Obviously, living in one unit will lower your net operating income. (FYI NOI=income-expenses. Do not include your mortgage payment in your expenses)
Some people like to use DSCR to estimate profitablity. In my mind it's just as easy to calculate cash flow. DSCR more than anything is for lenders. In my opinion you need at least 1.5 to break even.
Also, most lenders will add 75% of the income of a property to your income when they're figuring out your ratios.
Hope this helps
Thank you for your response. You information does help for sure, but I am still a bit confused. I am trying to come up with a "sanity check" formula to determine a) if this is a good idea financially and b) if so, which property will yield the best results.
Here are some sample numbers that I grabbed off of this forum:
Asking Price $145,000
Number of Units 1
Monthly Rent $1,000
Debt Service $9,348
Expenses
School and property tax $2,175
Insurance $435
Water and sewer $2,755
Trash removal $856
Electricity $2,030
Maintenance $2,538
Snow removal $435
Heat $1,595
Other $1,001
Total Expenses $13,819
Total Income $10,000
NOI -$3,819
DSC -0.41
I guess the question is what should I be looking for? In my current housing sitaution, I own my house and pay the mortgage. I have no renters, so no additional income. It seems that if I can purchase a duplex and at least have the renter offset my mortgage payment I will be better off than I am now.
Thanks,
Dave
Let's say for the purposes of this illustration, that you can buy a duplex for $100K (with 100% financing at 6%). Let's allocate $50K of our purchase price to the rental half of the duplex, and let's assume that market rents for similar properties are $700 per month.
Let's say that half of the hazard insurance and half of the property taxes are allocated to the operating expenses of the rental unit. Let's also say that the total operating expenses to include maintenance, cleaning, leasing expenses, advertising, plus any other operating costs average $100 per month, giving you a net operating income (NOI) of $600 per month ($700 rent minus $100 expense). Now half of the debt service (P and I only) is $300 per month. When you divide your NOI by your debt service you get a DCR of 2.0 for this rental unit. Subtracting your debt service for the rental from your NOI, leaves you with $300 per month positive cash flow.
Since your half of the debt service for your residence unit is only $300 per month, it appears that your cash flow from the rental would completely cover your residence unit debt service.
If you are able to stay fully rented, and you are happy with this arrangement, then take advantage of the opportunity to let your rental buy two properties for you while you live "rent free" in one of them. Of course, landlording next door to your tenant has to suit your temperment for this to be a positive experience.
Unless you can get a rental unit DCR of 2.0 or higher, you will have to come out of pocket for some of your personal residence mortgage expense.
So, based upon this illustration, it would appear that the magic DCR number you are looking for is 2.0 or higher, for the rental portion of the property only.
If you want to lump the entire costs for your debt service, property taxes, and hazard insurance for the building into the rental calculation (expense the total building against only one income), then a DCR of 1.0 will still breakeven, while a DCR of 1.25 or higher will give you a cash flow cushion to cover unscheduled repairs (e.g., that roof leak, or A/C breakdown).[ Edited by DaveT on Date 07/11/2003 ]
Thank you Dave. It makes more sense to me now, but I still have some questions. I will do some more research and see if I can clear them up.
Overall, it seems like it could be a wise financial move.
Dave
Quote:Some people like to use DSCR to estimate profitablity. In my mind it's just as easy to calculate cash flow. DSCR more than anything is for lenders. In my opinion you need at least 1.5 to break even. hibby76,
NOI - (Debt Service) = Cash Flow
NOI / (Debt Service) = DCR
While you may have a positive Cash Flow, the DCR indicates whether the cash flow is large enough to maintain the property.
By definition, a DCR of 1.0 is breakeven. I would like to hear why you feel a DCR of 1.5 should be defined as breakeven.
I live in a triplex, and rent the other two floors. I was careful about buying at a good price, and raised my rents to market. I started off living "rent (and expense) free" and now actually have positive cash flow from it-three years later.
In other words, my tenants pay PITI, repairs, etc (all expenses) and I wind up with $3k after taxes in my pocket at the end of the year.
It's all in finding the right house. Get one that will carry you, and good tenants, and you could be making a very good decision.
Now, my neighbor did the same thing, but didn't check the references on his tenants all that well. He couldn't take it and moved out. Now he has tenants paying sub market rents - if they pay at all - and he has a single family mortgage to pay off. All he had to do was to do his homework in the beginning and he wouldn't have had to deal with that mess.