Interest coverage ratio
The interest coverage ratio (ICR) shows how many times a property's operating income covers the interest costs on its loans. It is calculated as operating profit before interest, that is net operating income (NOI), divided by annual interest costs. An interest coverage ratio of 2.0 means the property earns twice as much as it pays in interest, and that there is a good margin before operations can no longer service the interest.
The metric is central to loan financing of commercial property. Lenders often set a minimum interest coverage ratio as a loan covenant, typically in the range 1.5 to 2.5 depending on the property's risk, the quality of the tenants and the length of the leases. If the limit is breached, the bank can demand repayment, additional security or, in the worst case, terminate the loan. Because the figure looks only at the interest cost, it is particularly sensitive to interest rate changes: a property with comfortable coverage at a 3% rate can come under pressure at 6%, unless the rate is hedged through an interest rate swap or a fixed rate.
The interest coverage ratio must be kept separate from the debt service coverage ratio (DSCR). The interest coverage ratio looks only at interest; the debt service coverage ratio looks at interest plus principal repayments, that is the total amount the property actually has to pay on the loan each year. For a loan with principal repayments, the debt service coverage ratio will therefore always be lower than the interest coverage ratio. Many loan agreements set requirements for both. A third, related figure is the loan-to-value ratio (LTV), which measures debt against value rather than against income. Together, the three give a picture of both earnings margin and financial strength.
For an investor, the interest coverage ratio is also an early warning of cash flow risk. A portfolio with low coverage copes poorly with a rate rise, higher vacancy and the loss of a large tenant at the same time. It is therefore read together with WAULT (remaining lease term) and the tenant mix: high coverage combined with short leases can be more vulnerable than moderate coverage with long, solid leases. In valuation and acquisition analysis, the interest coverage ratio is used to test how much gearing a property can realistically carry.
In Placepoint you can pull rental income, tenants and lease data from the property panel as a basis for calculating NOI and the interest coverage ratio in a financing analysis.
How it looks in Placepoint
In Placepoint you find this in the Property panel:
From Placepoint's dictionary: Interest coverage ratio
More information: Store norske leksikon: gjeldsgrad, Finanstilsynet
English: Interest coverage ratio (ICR).
Frequently asked questions
What is the interest coverage ratio?
The interest coverage ratio (ICR) shows how many times a property's operating income covers the interest costs. It is calculated as net operating income (NOI) divided by annual interest costs. Coverage of 2.0 means the property earns twice as much as it pays in interest.
What is the difference between the interest coverage ratio and the debt service coverage ratio?
The interest coverage ratio looks only at the interest cost. The debt service coverage ratio (DSCR) looks at interest plus principal repayments, that is the full amount the property has to pay on the loan. For a loan with principal repayments, the debt service coverage ratio is always lower.
What interest coverage ratio do the banks require?
It varies with risk, but lenders often set a minimum interest coverage ratio of 1.5 to 2.5 as a loan covenant. If the limit is breached, the bank can demand repayment, more security or termination of the loan.
Why is the interest coverage ratio sensitive to interest rate changes?
Because the figure measures only against the interest cost. A property with good coverage at a low rate can come under pressure when the rate rises, unless the rate is hedged through a fixed rate or an interest rate swap.