Debt Service Coverage Ratio (DSCR) Explained | Investor Guide

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Understanding the DSCR: The Key Metric for Rental Financing

The debt service coverage ratio (DSCR) is the fundamental criterion that every commercial lender examines when an investor applies for rental property financing. This ratio answers a simple question: does the building generate enough net income to cover its mortgage payments with a safety margin? For real estate investors in Quebec and across Canada, mastering the DSCR is essential for structuring strong financing applications.

DSCR (Debt Service Coverage Ratio): A financial metric calculated by dividing a building's annual net operating income (NOI) by the total annual debt service (principal + interest). Formula: DSCR = NOI / Debt Service. A DSCR above 1.00 indicates the building generates more income than what is needed to cover mortgage payments.

How to Calculate the DSCR Step by Step

Calculate effective gross rental income: Add all monthly rents actually collected and multiply by 12. Include ancillary income (laundry, parking, storage). Lenders use current rents, not projected rents.
Subtract the vacancy and bad debt provision: Apply a vacancy factor of 3% to 5% of gross income. This percentage varies by market and building history. You obtain the effective gross income.
Subtract normalized operating expenses: Deduct all operating expenses: property taxes, insurance, maintenance and repairs, management (typically 3% to 5% of income), owner-paid utilities, and a provision for major component replacement. The result is the net operating income (NOI).
Calculate the annual debt service: Déterminé total annual mortgage payments (principal and interest) based on the requested loan amount, interest rate, and amortization period.
Divide NOI by debt service: Dividing NOI by the annual debt service gives you the DSCR. Example: NOI of $120,000 / debt service of $100,000 = DSCR of 1.20.

Thresholds Required by Canadian Lenders

DSCR thresholds vary by lender type and financing program. CMHC's MLI Select program for multi-unit rental buildings generally accepts a minimum DSCR of 1.10, the lowest threshold in the market. Major Canadian banks (Schedule I banks under the Bank Act) typically require a DSCR of 1.20 to 1.25. Desjardins caisses, very active in multi-unit financing in Quebec, apply similar thresholds. Alternative lenders and mortgage finance companies may require DSCRs of 1.25 to 1.30, reflecting the higher risk profile of their portfolios.

Strategies to Optimize Your DSCR

Several strategies can improve a financing file's DSCR. On the revenue side, ensure rents reflect the current market and document any subletting or ancillary income. Reduce vacancy by keeping the building in good condition and providing responsive service to tenants. On the expense side, optimize energy costs, negotiate insurance premiums, and plan preventive maintenance to avoid costly repairs. On the financing side, a higher down payment reduces debt service and mechanically improves the DSCR. Extending the amortization period (from 25 to 30 years, or up to 40 years with CMHC in certain cases) also reduces annual payments. Finally, negotiate the best possible rate: every 0.25% counts on a loan of several hundred thousand dollars.

Frequently Asked Questions

What exactly is the DSCR?

The debt service coverage ratio (DSCR) measures a rental property's ability to generate enough net income to cover its mortgage payments. It is calculated by dividing the net operating income (NOI) by the annual debt service (principal + interest). A DSCR of 1.20 means the building generates 20% more income than what is needed to cover payments.

What minimum DSCR do Canadian lenders require?

Most conventional lenders require a minimum DSCR of 1.20 to 1.30. CMHC's MLI Select program may accept a DSCR as low as 1.10 for insured rental buildings. Alternative or private lenders may have different thresholds but generally also apply a minimum DSCR to assess risk.

How can I improve a building's DSCR?

There are two main levers: increase the NOI or reduce the debt service. To increase NOI, you can optimize rents to market rates, reduce operating expenses, or decrease vacancy. To reduce debt service, you can increase the down payment, extend the amortization period, or negotiate a better interest rate.

Does the DSCR replace GDS and TDS ratios for 5+ unit buildings?

For five-or-more-unit buildings financed commercially, the DSCR is indeed the primary ratio used by lenders, replacing the gross debt service (GDS) and total debt service (TDS) ratios that apply to residential loans. However, some lenders also examine the borrower's personal financial situation as a complement.

How does Quebec's Tribunal administratif du logement affect the DSCR?

The TAL governs rent increases in Quebec. Lenders account for this by using current rents rather than optimistic projections. If rents are below market, the ability to increase them is limited by TAL indices, which can reduce projected NOI and therefore the DSCR. A broker must properly document the rental history to present a realistic picture.