Wealth Opportunities in Commercial Real Estate: Management, Financing, and Marketing of Investment Properties

Loan Underwriting

The amount of the loan is usually a key element in structuring the debt, but you must understand that determining the loan amount, “sizing the debt,” is a negotiated process. Lenders “underwrite” a loan request to come up with the quoted dollar amount. I do not mean to suggest that the quoted dollar amount is a given, not subject to discussion, but rather that it usually is the starting point in the negotiation.

Financial institutions will usually underwrite off the Cash-Flow-before-Debt-Service figure. In other words, after deducting the operating expenses from the project's income, they will also deduct reserves, that is, their estimate of annually recurring capital expenditures, tenant improvement costs, leasing commissions, and the like. The figures used to make up the income and expense schedule are called “trailing 12-month figures.” They are historical numbers for the past 12 months. If the owner has had significant success in leasing up the property in the recent past, possibly the lender will allow the current rent roll to be annualized, but in most cases the trailing 12-months' income will be utilized. Similarly, the past 12 months reimbursed expenses and the past 12 months operating expenses will be used in the analysis. Please refer to Exhibit 5.2 for a month-by-month detailed breakdown of the income and expenses for our hypothetical project.

In our hypothetical example in the beginning of Chapter 2, we assumed a debt level of $7,650,000 based upon ...