How to Underwrite a Commercial Real Estate Deal (Step-by-Step)
Learn CRE underwriting for beginners: NOI, rent roll, expenses, capex, debt, returns, and a simple model process with a blended example.
Why Underwriting Matters (In Plain English)
Underwriting is simply forecasting how a property will perform financially—so you can decide:
Is the price justified?
What can go wrong?
How do we make money (and how do we protect downside)?
At CTR Capital, we underwrite deals like a business plan, not a hope-and-a-prayer spreadsheet. Beginners win by being conservative, consistent, and disciplined.
Step 0: Know What You’re Underwriting (The “5-Minute Context”)
Before you touch the numbers, answer five questions:
What is it? (industrial, retail, mixed-use, multifamily 5+?)
Who pays? (tenants, reimbursements, short-term stays, etc.)
How stable is income? (lease terms, tenant concentration, occupancy)
What’s the building condition? (roof, HVAC, parking, deferred maintenance)
What’s the business plan? (hold stable, light value-add, heavy reposition?)
Beginner rule: If you can’t summarize the value proposition in 1–2 sentences, you’re not ready to underwrite it.
Step 1: Gather the Core Documents (What You Need)
A proper underwriting starts with these basics:
Rent roll (current tenant list, rents, lease start/end, SF, deposits)
T-12 (trailing 12 months income & expenses)
Real estate tax bill
Insurance quote or historical
Utility bills (if landlord-paid)
Service contracts (snow, landscaping, trash, elevator, etc.)
Leases + amendments (at least for major tenants)
If you don’t have these, you can still “screen” a deal—but full underwriting requires real data.
Step 2: Build Your Income (The Top Line)
There are four common income buckets:
1) Base Rent
From the rent roll. Verify:
contract rent (what the lease says)
collected rent (what’s actually being paid)
upcoming lease expirations (risk and opportunity)
2) Reimbursements (Often in Retail/Industrial)
In NNN or modified gross leases, tenants reimburse:
taxes, insurance, CAM/maintenance (varies by lease)
Beginner pitfall: assuming reimbursements are perfect. They aren’t unless the lease language + billing is tight.
3) Other Income
Examples:
parking
storage
late fees
laundry (multifamily)
signage
billbacks (admin fees)
4) Vacancy & Credit Loss (Don’t Skip This)
Even “100% occupied” buildings deserve a vacancy assumption.
Beginner-friendly baseline:
Retail/Industrial: 5–8% stabilized vacancy (market-dependent)
Office: often higher (depends on submarket)
Multifamily: 3–6% typical
Mixed-use: use blended assumptions per component
Step 3: Build Operating Expenses (The Reality Check)
Operating expenses are where beginner underwrites go off the rails.
Typical expense categories
property taxes
insurance
repairs & maintenance
utilities (if landlord-paid)
management fees
snow/landscaping
cleaning/janitorial (common areas)
trash removal
admin/legal/accounting
marketing/leasing (especially if vacancy)
Two beginner mistakes:
Using seller’s expenses without verifying (they may be under-reporting).
Forgetting “future reality”—insurance and taxes can reset after sale.
CTR Capital habit: We compare T-12, market norms, and “post-sale likely” (tax reassessment, insurance repricing).
Step 4: Calculate NOI (Your Core Metric)
NOI (Net Operating Income) = Effective Gross Income – Operating Expenses
(NO debt service here)
NOI is the engine of value in CRE. Increase NOI → increase value.
Step 5: Add CAPEX + Leasing Costs (Where Beginners Get Blindsided)
CAPEX and leasing costs often determine whether a deal is truly “value-add” or just “value-trap.”
CAPEX examples (blend)
Retail: roof, parking lot, façade, signage, exterior lighting
Industrial: overhead doors, dock equipment, HVAC units, electrical upgrades
Mixed-use: unit turns, kitchens/baths, code upgrades
Multifamily 5+: roofs, boilers, common areas, unit upgrades
Leasing costs (commercial)
Tenant Improvements (TI): buildout money
Leasing Commissions (LC): paid to brokers for leasing space
Free rent / concessions: especially in softer markets
Beginner tip: If a lease expires soon, assume you will pay something to keep/replace that tenant.
Step 6: Add Debt (How Financing Changes Returns)
Most beginner underwrites should include conservative debt assumptions:
Key terms to know:
LTV (Loan-to-Value): loan / value
DSCR: NOI / annual debt service
Debt yield: NOI / loan amount (common lender risk metric)
Beginner baseline thinking:
If a deal barely covers DSCR in year 1, it’s fragile.
Short-term floating rates can materially change outcomes—underwrite a rate cushion.
Step 7: Project Returns (What You’re Really Buying)
At minimum, track these:
Cash-on-cash return: annual cash flow / cash invested
IRR (Internal Rate of Return): time-weighted return over hold period
Equity multiple: total cash back / cash invested
Beginner-friendly: start with cash flow + equity growth and don’t obsess over one “perfect” metric.
Step 8: Underwrite a Downside Case (Non-Negotiable)
A beginner’s best friend is a simple downside scenario:
vacancy takes 6–12 months longer
rents grow slower (or flat)
expenses run 10–15% higher
capex costs 10–20% higher
exit cap rate is 50–100 bps higher
If the deal collapses under mild stress, it’s not a deal—it’s a gamble.
A Blended Example (Retail + Industrial + Mixed-Use Logic)
Imagine a mixed-use building:
Ground floor: 2 retail suites (NNN-ish reimbursements)
Back: 1 small industrial/flex tenant
Upstairs: 4 residential units (multifamily-style)
Income (annual)
Retail base rent: $90,000
Industrial base rent: $60,000
Residential rent: $96,000
Other income (parking/laundry): $6,000
Gross scheduled income: $252,000
Vacancy (5% blended): -$12,600
Effective gross income: $239,400
Expenses (annual)
Taxes: $28,000
Insurance: $12,000
Repairs & maintenance: $18,000
Utilities (common + res): $14,000
Management (6% of EGI): $14,364
Snow/landscaping/trash/common: $9,500
Total expenses: ~$95,864
NOI
$239,400 – $95,864 = $143,536 NOI
If purchase price is $2,050,000:
Cap rate (in-place) ≈ $143,536 / $2,050,000 = 7.0%
Now a simple value-add:
bring one residential unit up by $150/month at turnover (+$1,800/yr)
lease a small retail vacancy at +$8/SF (+$8,000/yr)
reduce expenses by rebidding landscaping/snow (-$2,500/yr)
That’s ~$12,300 NOI improvement.
At a 7% cap rate, value impact ≈ $12,300 / 0.07 = $175,714 (before capex/leasing costs).
That’s underwriting in the real world: small moves compound.
Beginner Underwriting Checklist (Copy/Paste)
Use this every time:
Verify income: rent roll + lease terms + collections reality
Normalize vacancy: stabilized assumption even if full today
Normalize expenses: taxes/insurance “post-sale likely”
Include capex: immediate + near-term (24–36 months)
Include leasing costs: TI/LC/concessions if lease roll risk
Model debt conservatively: include rate cushion
Run a downside case: slower lease-up + higher exit cap
Only then decide: price, terms, or pass
FAQs
What’s the difference between NOI and cash flow?
NOI is before debt service; cash flow is after debt.
Do I need a full model to start?
No. Start with a 15-minute screen, then deepen only on deals that pass.
What’s a “good” DSCR for beginners?
Enough cushion to survive. Many lenders like 1.20–1.30+, but it varies.
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