Underwriting
The process by which a lender evaluates the risk and determines the terms of a proposed commercial real estate loan. Underwriting involves analyzing the property's income and expenses, market conditions, borrower financial strength, and collateral value. Lenders stress-test assumptions including vacancy, rental growth, and interest rate scenarios. The underwritten NOI, which may differ significantly from the borrower's pro forma, determines the maximum loan amount through LTV, DSCR, and debt yield constraints.
Related Terms
NOI (Net Operating Income)
A property's annual income after deducting operating expenses but before debt service, capital expenditures, and income taxes. NOI is calculated as Effective Gross Income minus Operating Expenses. It is the fundamental metric used to value commercial real estate and determine borrowing capacity.
DSCR (Debt Service Coverage Ratio)
A measure of a property's ability to cover its debt obligations, calculated by dividing Net Operating Income (NOI) by annual debt service. Lenders typically require a minimum DSCR of 1.20x to 1.35x, meaning the property generates 20-35% more income than needed to pay the mortgage. Higher DSCRs indicate lower risk and may qualify for better loan terms.
LTV (Loan-to-Value Ratio)
The ratio of a loan amount to the appraised value of a property, expressed as a percentage. For example, a $7 million loan on a $10 million property has a 70% LTV. Lower LTVs represent less risk to lenders and typically result in better rates. Maximum LTVs vary by lender type: life companies (55-65%), CMBS (up to 75%), and agencies (up to 80% for multifamily).
Debt Yield
A risk metric calculated by dividing Net Operating Income by the total loan amount, expressed as a percentage. For example, $1 million NOI on a $10 million loan equals a 10% debt yield. Unlike LTV and DSCR, debt yield is independent of interest rates and cap rates, making it a pure measure of loan risk. Most lenders require minimum debt yields of 8-10%.
Term Sheet
A non-binding document outlining the key terms and conditions under which a lender is prepared to make a commercial real estate loan. Term sheets typically include proposed loan amount, interest rate or pricing, term, amortization, LTV and DSCR requirements, recourse provisions, prepayment terms, reserve requirements, and closing conditions. Borrowers often solicit multiple term sheets to compare options. A signed term sheet typically triggers a good-faith deposit, exclusivity period, and formal underwriting.
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