Understanding Commercial Real Estate Loan Underwriting

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Knowing and understanding real estate loan underwriting is important and valuable in any CRE transaction.

In this article:

  1. An Overview of Real Estate Loan Underwriting
  2. What is Underwriting?
  3. Understanding Net Operating Income (NOI)
  4. Understanding Loan to Value Ratio (LTV)
  5. Understanding Debt Service Coverage (DSCR)
  6. Understanding Maximum Loan Analysis

Real Estate Loan Underwriting | What It Is


An Overview of Real Estate Loan Underwriting

Commercial underwriters consider a number of variables before approving a mortgage request. It’s a process that has become more mainstream in the last few years.

Defining underwriting and understanding how all the pieces fit together makes it easier for buyers looking to invest in property.

It starts with a brief meeting between the borrower and the financier to clarify basic details like interest rates and lending policies. From there, the real underwriting process begins.

What is Underwriting?

Underwriting refers to assuming the risk of another party for a fee. For example, the insurance industry uses underwriters. They assume the risk of an accident or an illness and make revenue in return.

The mortgage underwriting definition, sometimes called manual underwriting, refers to underwriting real estate to approve or deny a loan based on risk factors like the property value, the buyer’s credit history, and the other financial indicators such as debt ratios.

It is the underwriter’s job to ensure the applicant meets the standards for a loan and to determine how much they can borrow using tools like net operating income, loan to value ratio, and debt service coverage.

How long does underwriting take? Typically, the borrower will have a minimum of 10 days but it could take longer.

Understanding Net Operating Income (NOI)

man sitting car using parking machine | Understanding Commercial Real Estate Loan Underwriting | what is underwriting

When asking what underwriting means, the first term to learn is net operating income or NOI. Net operating income gives lenders an idea of how much revenue a commercial property could generate. The basic formula for NOI is:

Property revenue – operating expenses = NOI

Typically, the buyer and the lender each create their own NOI figure. The borrower will submit documents like a rent roll or proforma while the lender creates a second version based on their data. The lender may make adjustments in their NOI that include things like:

  • Credit loss factor
  • Vacancy rates
  • Tenant rollover risk
  • Reserves for replacement

The goal is to determine if the property has a positive net operating income. For instance, if the property revenue is $100,000 and the operating costs are $20,000, it generates revenue instead of creating debt.

Examples of operating revenue would be rent, parking facility use fees, and on-site laundry. Expenses would include property management fees and real estate taxes.

RELATED: Commercial Real Estate Financing Basics | What It Is and How It Works

Understanding Loan to Value Ratio (LTV)

Once the NOI calculation is complete, the underwriter considers the loan to value ratio. LTV means the loan amount as it relates to the value of the property. If the loan value is $100,000 and the property worth based on an appraisal is $150,000, the LTV is 67%.

100,000/150,000 = .67 or 67%

LTV means the borrower needs 67% of the total property value in the loan. The lender will use its internal loan policy guidelines to evaluate the LTV, and may even refer to similar projects as a comparison.

Lenders will typically base the property value on an appraisal from a third-party firm and may also make adjustments that decrease the value further.

Understanding Debt Service Coverage (DSCR)

The next step in the underwriting process is calculating debt service coverage or DSCR. The goal of the DSCR is to figure out if the property generates enough cash flow to cover the loan payments.

Underwriters figure DSCR by taking the NOI or net operating income and dividing it by the annual debt service, or yearly payments due. For instance, if the loan payment toward the principle for the commercial property is $1,000 a month and the interest payment is $200 per month, the annual debt service is $14,400 per year.

(1,000 x 12) + (200 x 12) = $14,400 Annual Debt Service

To calculate the DSCR, the lender divides the NOI by that number. As part of the lending policy, they will require a certain DSCR to approve the loan, often around 1.25x.

In other words, the NOI must be 1.25 x the DSCR to create a cushion that increases the odds of the lender getting monthly loan payments. If the DSCR is $14,400, the NOI would need to be at least $18,000 yearly to get the loan.

At that rate, the property will still make enough to cover loan payments even if the NOI drops some, giving the lender a cash cushion to ensure monthly payments.

18,000/14,400 = 1.25x DSCR

Understanding Maximum Loan Analysis

Finally, the Maximum Loan Analysis takes all three factors, NOI, LTV, and DSCR into account to figure out the highest loan for this borrower. Maximum loan analysis is a concept used in both residential and commercial lending.

For commercial properties, the underwriters calculate the appropriate net operating income for the property. They use that number to figure the loan to value (LTV) ratio and the debt service coverage (DSCR).

The lesser of the two loan amounts determined for the LTV and DSCR is the maximum loan analysis and the most a buyer can borrow for this one property.


The loan underwriting process is not a difficult one to grasp, and it is essential to understand it, especially if you are considering entering into the world of commercial real estate.

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