Every Canadian real estate investor encounters three metrics early in their journey: cap rate, cash-on-cash return, and DSCR. Each one measures something different. Each one answers a different question. Using the wrong metric to make a decision is one of the most common analysis mistakes new investors make.
This post explains what each metric actually measures, when to use it, and how they work together to give you a complete picture of any deal.
Calculate all three on any property using the free calculators here.
Cap Rate: The Property Without the Financing
Cap rate measures a property's return independent of how you finance it. It assumes you bought the property for cash with no mortgage.
Cap Rate = Net Operating Income / Purchase Price
NOI is rent minus vacancy minus operating expenses, excluding the mortgage.
Cap rate is most useful for two purposes. First, comparing properties against each other. A 5.5% cap rate property in Hamilton versus a 4.2% cap rate property in Toronto tells you something about relative value, holding quality and risk constant. Second, comparing against market benchmarks. In Toronto, cap rates typically run 3.5 to 5%. In secondary Ontario markets, 5 to 7%. Understanding where your property sits relative to the market tells you whether you are paying a premium or getting value.
What cap rate does not tell you: whether you will make money after paying the mortgage. Two investors buying the same property at the same cap rate with different financing structures will have completely different cash flow outcomes. This is where cash-on-cash return comes in. For a deeper look at how cap rate thresholds vary by Ontario market, see How to Analyze a Rental Property in Canada.
Cash-on-Cash Return: Your Money Working for You
Cash-on-cash return measures what your out-of-pocket investment is actually earning after all costs including the mortgage.
Cash-on-Cash Return = Annual Pre-Tax Cash Flow / Total Cash Invested
Total cash invested includes your down payment, closing costs, and any immediate repairs. Annual pre-tax cash flow is rent minus all expenses including the mortgage payment.
Cash-on-cash return lets you compare real estate against other investments. If your rental property generates 6% cash-on-cash and a GIC is paying 4.5%, the rental is outperforming on cash yield. If your rental is generating negative 3% cash-on-cash, you are subsidizing the property from other income, which may or may not be worthwhile depending on appreciation expectations.
A generally accepted benchmark: below 5% is weak, 5 to 8% is moderate, above 8% is strong for Ontario real estate. These are guidelines, not rules.
What cash-on-cash does not tell you: whether a lender will finance the deal. That is what DSCR measures. For the full breakdown of lender thresholds and how to improve a low number, see What Is a Good DSCR for a Canadian Rental Property.
DSCR: The Lender's Metric
Debt Service Coverage Ratio is the metric lenders use to decide whether to approve financing. It answers whether the property's income covers its mortgage payments.
DSCR = Net Operating Income / Annual Mortgage Payments
Most Canadian lenders require a minimum of 1.20x to 1.25x. Below 1.0 means the property does not earn enough to cover its mortgage. Above 1.25x means it earns significantly more than required.
DSCR is primarily a financing metric. It determines whether you can get the mortgage, which determines whether you can buy the property at all.
How They Work Together
The three metrics answer three different questions in sequence:
- Cap rate: Is this property priced fairly relative to its income and the market?
- DSCR: Will a lender finance this deal?
- Cash-on-cash return: What is my invested capital actually earning?
A complete deal analysis uses all three. Here is how they interact on the same property:
Example: $700,000 property, $3,800 monthly rent, $14,400 annual operating expenses, 20% down at 4.5%.
- NOI: ($3,800 x 12 x 0.95) - $14,400 = $43,320 - $14,400 = $28,920
- Cap rate: $28,920 / $700,000 = 4.1%
- Annual mortgage on $560,000: approximately $36,744
- DSCR: $28,920 / $36,744 = 0.79x
- Annual cash flow: $28,920 - $36,744 = -$7,824
- Cash-on-cash: -$7,824 / $154,000 (down payment + closing costs) = -5.1%
Cap rate of 4.1% is reasonable for Ontario but not exceptional. DSCR of 0.79x will not qualify for standard investment financing. Cash-on-cash of negative 5.1% means you are losing cash each year on the investment before considering equity and appreciation.
Three metrics, three clear answers, one complete picture.
Which Metric Should You Focus On?
The honest answer: all three, in the right order.
Use cap rate first for screening. If the cap rate is well below market, you are paying a premium that requires a strong appreciation thesis to justify. Use DSCR second to confirm financing is possible. If DSCR is below lender thresholds, you need to restructure the deal before proceeding. Use cash-on-cash last to understand your actual yield on invested capital.
Investors who focus only on cap rate ignore financing costs. Investors who focus only on cash-on-cash ignore whether the deal can be financed. Investors who focus only on DSCR ignore whether the deal is fairly priced. The complete picture requires all three.
This post is for informational purposes only and does not constitute financial, legal, mortgage, or tax advice. All figures are illustrative estimates based on example inputs. Actual results depend on your specific circumstances. Consult a qualified professional before making any investment decision.
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