There is a moment I see often when reviewing deals.
An investor scans the underwriting, pauses at one line item, and feels reassured.
“DSCR is at or well above 1.25x. We should be fine.”
That assumption is one of the most dangerous shortcuts in multifamily investing.
Because a deal can show a 1.25x debt service coverage ratio, remain in full covenant compliance, and still miss a mortgage payment.
It sounds contradictory. It is not.
It is simply the difference between what a metric measures and what actually determines whether cash leaves the bank account on time.
This distinction matters even more so today than it has in past years.
DSCR Measures Coverage. Not Cash or Free Cash Flow.
At its core, DSCR is a simple ratio.
DSCR = NOI / Debt Service
It answers a narrow question: does net operating income cover scheduled principal and interest payments?
That is very useful. Lenders rely on it for a reason.
However, notice what is not captured in that equation.
DSCR does not account for capital expenditures. It excludes working capital swings, timing mismatches in collections, and real-world cash leakage. It does not reflect reserve requirements, escrow funding, or unexpected operational shocks. It does not reflect principal payments (if the loan is amortizing).
In other words, DSCR is based on NOI, not free cash flow.
In addition, NOI is not a liquidity measure.
A property can meet a DSCR covenant and still run out of cash.
The Real Question Is Free Cash Flow
If the goal is to assess whether a loan will actually be paid, the more relevant question is not coverage. It is residual cash and cash flow.
What remains after all required uses of capital?
In practice, the equation looks closer to this:
NOI minus debt service, minus recurring and non-recurring CapEx, plus/minus working capital needs, minus any distributions.
What is left is free cash flow available to support the business.
This is where many deals quietly break.
A property may show a 1.25x DSCR on paper, but if it is absorbing elevated turn costs, catching up on deferred maintenance or high capex, dealing with delayed collections, higher escrows, or facing insurance and tax resets, that “coverage” can evaporate quickly in cash terms.
I have seen deals where NOI held relatively steady, DSCR remained compliant, and yet the property was burning cash every month.
The income statement looked stable.
The cash flow statement told the truth.
Liquidity Is Built, Not Assumed
The next layer is reserves.
This is where discipline, or the lack of it, becomes visible.
If a deal has not adequately funded capital expenditure reserves or debt service escrows, then every unexpected cost flows directly through operating cash.
That creates fragility.
A single large repair, a series of tenant turns, or a temporary dip in collections can consume the liquidity needed for the next mortgage payment.
This is how you end up with a deal that technically “works” from a DSCR perspective, but still defaults in practice.
When I review a deal, I am not only interested in what NOI was generated but also in what cash flow was generated.
Because free cash flow is the life blood of a business and what pays the loan.
Sources and Uses Tell You What DSCR Cannot
This is where cash flow forecasting becomes critical.
Understanding liquidity requires a clear view of both sources and uses of cash.
On the source side, you have operating cash flow, existing reserves, sponsor support, and any available credit facilities or capital partners.
On the use side, you have debt service, CapEx, vendor payables, tax and insurance escrows, payroll, and all the operational realities that do not show up cleanly in NOI.
When uses begin to exceed sources, the question becomes simple.
How long can the property sustain the burn?
This is the concept of cash burn analysis.
At the current run rate, how many months of liquidity remain?
That single question will often tell you more about default risk than DSCR ever will.
The Hidden Layer: External Liquidity
There is one more layer that sophisticated investors and family offices pay close attention to.
Liquidity does not exist only at the property level.
It exists across the capital stack and the sponsor’s balance sheet.
Even if a property is temporarily cash flow negative or liquidity constrained (at the business entity level), a loan payment may still be made if there is external support. This could come from sponsor liquidity, capital calls, lines of credit, or rescue capital in the form of preferred equity.
Conversely, a property with acceptable DSCR but no access to outside liquidity is far more exposed.
This is why I often say the lender is the largest partner in the deal.
However, the sponsor’s liquidity profile is a close second.
Why This Matters Today
In the current environment, many multifamily assets are experiencing exactly this dynamic.
Deals underwritten in a different rate and expense environment are now facing higher operating costs, insurance resets, and slower rent growth. Some remain technically compliant from a DSCR standpoint.
But operationally, they are strained.
The gap between accounting income and actual cash has widened.
And that is where defaults begin.
The Takeaway
A 1.25x DSCR does not guarantee that a loan will be paid.
It only tells you that NOI covers scheduled debt service on paper.
It does not tell you whether the property has sufficient free cash flow, whether reserves are adequate, whether liquidity is being consumed, or whether external support exists.
That is the difference between covenant compliance and payment reality.
For investors, operators, and family offices, this is where the focus needs to shift.
From static ratios to dynamic cash flow.
From income statements to liquidity.
From underwriting at acquisition to ongoing cash flow forecasting.
If you are reviewing deals and want a second set of eyes on true free cash flow risk, feel free to connect. These are the details that often get missed, and they are the ones that matter most when the market tightens.
I would be curious to hear your perspective as well.
Have you seen deals that looked strong on DSCR but weak on liquidity underneath the surface?
Vessi Kapoulian
Breaking down multifamily underwriting one step at a time to create educated and empowered investors
P.P.S. And if you want to go deeper into analyzing multifamily investments step-by-step, my book and Mastering Multifamily Underwriting program walk through this process in plain English – from acquisition to exit.