Commercial real estate (CRE) loan underwriting is the process by which a lender assesses the creditworthiness of a property-backed loan. Unlike C&I underwriting, which emphasizes the borrower's enterprise cash flows, CRE underwriting centers on the income-generating capacity of the underlying property and the value of the collateral.
The two most fundamental CRE underwriting ratios are the loan-to-value ratio (LTV) and the debt service coverage ratio (DSCR). LTV measures the loan amount as a percentage of the property's appraised value — a 65% LTV means the loan is 65% of value, with 35% equity cushion. DSCR measures the property's net operating income (NOI) relative to its annual debt service — a 1.25x DSCR means the property generates 25% more income than needed to service the debt.
Lenders also analyze stabilized occupancy and market vacancy rates, tenant quality and lease terms, expense ratios, capital expenditure requirements, and the sponsor's track record. Properties with long-term leases from creditworthy tenants (e.g., net lease retail) are underwritten more favorably than properties with near-term rollover risk or weak tenant profiles.
Appraisals play a central role in CRE underwriting. Lenders commission third-party MAI-certified appraisals using three approaches to value: the income approach (capitalized NOI), the sales comparison approach (comparable transactions), and the cost approach (replacement cost of improvements plus land value). The income approach typically drives the analysis for income-producing properties.
Stress testing is a critical component of CRE underwriting. Lenders analyze performance under downside scenarios — occupancy drops, cap rate expansion, interest rate increases — to ensure the property can sustain debt service and the lender can recover principal in a liquidation. The severity of stress applied typically increases with leverage, loan size, and property type cyclicality.