Which Return Metric Should Drive Your Buy

Three numbers get quoted on every rental deal, and they are not interchangeable. Using the wrong one to make the decision is how investors end up owning something that looks good on a spreadsheet and starves them of cash.

Cap rate: comparing assets, not deciding

Cap rate is NOI divided by price. It contains no financing at all, which is precisely what makes it useful: it lets you compare two buildings without your loan terms distorting the picture.

And precisely what makes it a poor decision metric. It tells you nothing about whether the deal works for you, at your leverage, with your cost of capital. Two investors buying the same building at the same cap rate can have completely different outcomes.

Use it to compare. Do not use it to decide.

Cash-on-cash: what you actually earn

Cash-on-cash is annual pre-tax cash flow divided by cash invested. This is the number that answers "what is my money earning", and it is the one most investors should lead with, because it includes financing.

Its weakness is that it flatters leverage. Push leverage up, put less cash in, and cash-on-cash rises even as the deal gets more fragile. A high cash-on-cash on thin coverage is a deal with no margin for a vacancy.

DSCR: whether it survives

On a rental, DSCR is the monthly rent divided by the full monthly payment - principal, interest, taxes, insurance and any HOA. At 1.00 the rent exactly covers the payment and nothing else. At 0.90 it does not. On commercial deals the same ratio is expressed as NOI over debt service; the question it answers is identical.

It is not a return metric at all. It is a durability metric.

This is also the number your lender qualifies on. Our DSCR program goes from 0.75, which means a property can qualify while still needing support from you. That is a real option, and it should be a deliberate choice rather than a surprise. How to calculate DSCR works through it.

How to use all three

• Cap rate to shortlist and compare. Is this priced sensibly for the submarket?
• DSCR to check survival. Does it carry itself, and will it still at a realistic vacancy?
• Cash-on-cash to decide. Is this the strongest use of the capital I am about to commit?

Run a deal that clears all three and you have something. Run one that clears only cash-on-cash and you have leverage dressed up as a return.

The one none of them capture

None of these include your total cost of capital on entry, or a prepayment penalty on exit. Add both before you commit.

Model them in the cap rate calculator and the DSCR calculator. Not a commitment to lend.