Break-even ratio (sometimes called default ratio) is often used by lenders when considering to underwrite a loan for an real estate investment property. In effect, it tells the lender how vulnerable a property might be to defaulting on its debt in the event rental income derived from the real estate income property should decline.
Whereas rental income represents the inflow of cash, the property’s operating expenses and debt service (the loan payment) represents an out flow of cash. The bottom line, of course, represents cash flow. And cash flow, obviously, is what a real estate investor (as well as the bank) like to see a property producing a lot of. When the income, however, drops off, so will the cash flow; sometimes dangerously close to a point that would cause the investor to perhaps miss a payment. The break-even ratio, therefore, gives the banks a benchmark of what percentage revenue must decline before cash flow would break even with the loan payment.
