CRE Underwriting Workflow

Underwriting begins with the rent roll — a detailed schedule of every tenant, their suite or unit, square footage, lease start and end dates, current rent, escalation schedule, and any concessions. The first step is validating the rent roll against market data: Are in-place rents at, above, or below market? When do leases expire? What is the risk of non-renewal? Tenant concentration — the percentage of income derived from the top 1-3 tenants — is a critical risk metric; any single tenant representing more than 25% of income creates meaningful rollover risk.

From the rent roll, calculate Gross Potential Income (GPI) — the income the property would generate if fully occupied at current contract rents. Then apply a vacancy and credit loss factor (typically 5-10% for stabilized properties, higher for properties with near-term lease expirations). The result is Effective Gross Income (EGI). Add any miscellaneous income — parking, storage, vending, antenna leases — to arrive at total effective income.

Review historical operating expenses from the trailing 12-month (T12) statement and compare to market benchmarks. Key expense categories include property taxes (verify with the local assessor — taxes often reset upon sale), insurance (obtain a quote for the specific property), utilities (examine seasonal patterns), maintenance and repairs (distinguish between recurring and non-recurring items), property management (typically 4-8% of EGI for third-party management), and capital reserves (typically $0.10-$0.30/SF annually for major system replacements).

Subtract total operating expenses from Total Effective Income to arrive at Net Operating Income (NOI). This NOI becomes the numerator in your cap rate calculation, the basis for your DSCR analysis, and the foundation for your multi-year cash flow projection. Getting NOI right is the single most important step in CRE underwriting — errors here cascade through every subsequent calculation.

With NOI established, size the debt based on lender requirements. Start with the most constraining of three tests: (1) LTV — multiply the appraised value by the maximum LTV (e.g., $5M value x 75% LTV = $3.75M max loan); (2) DSCR — divide NOI by the minimum DSCR and the result is the maximum annual debt service, then calculate the corresponding loan amount; (3) Debt yield — divide NOI by the minimum debt yield to find the maximum loan amount. The smallest of the three results is the maximum loan.

Finally, calculate equity returns. Cash-on-cash return = annual before-tax cash flow / total equity invested. Build a 5-10 year pro forma projecting rent growth, expense escalation, and capital expenditures. Calculate the projected exit value using a terminal cap rate (typically 25-50 basis points above the going-in cap rate to account for aging). Compute the IRR and equity multiple to evaluate whether the investment meets your return targets.