7 Key Metrics for Commercial Real Estate Underwriting

Smart commercial real estate underwriting starts with mastering the right metrics. Whether you're an investor, analyst, broker, or lender, understanding these financial indicators helps you evaluate opportunities, minimize risk, and make better decisions.

In this guide, we'll walk through seven core metrics used to assess a commercial real estate investment. These aren't just formulas—they're decision-making tools. By the end, you'll be equipped to break down complex deals and spot great (or risky) investments with confidence.

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1. Net Operating Income (NOI)

Net Operating Income (NOI) is a property's revenue minus its operating expenses. It gives a clear view of how much income a property is generating before considering financing or taxes.

Formula:

NOI = Effective Gross Income – Operating Expenses

Effective Gross Income (EGI) includes potential rental income, minus vacancy and credit losses, plus any additional income (e.g., parking, storage, signage).

Operating Expenses include property taxes, insurance, utilities, management fees, repairs, and administrative costs. NOI excludes debt payments, depreciation, income taxes, capital expenditures, and tenant improvement allowances.

Why It Matters:

• Offers an apples-to-apples way to compare properties

• Serves as the input for cap rate, DSCR, and more

• Indicates how well a property performs on its own, before financing

Example:

• Potential Rent: $500,000

• Vacancy Loss (5%): -$25,000

• Other Income: $30,000

• EGI = $505,000

• Operating Expenses: $155,000

• NOI = $350,000

Best Practices:

• Use trailing 12-month (T12) data if available

• Scrutinize expense assumptions (e.g., underreported taxes or management fees)

• Adjust for one-time events to determine stabilized NOI

Common Mistakes:

• Including CapEx or loan payments in NOI

• Ignoring below-market rents that may impact future NOI

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2. Capitalization Rate (Cap Rate)

Cap Rate tells you the yield of a property if you paid all cash. It’s used to estimate value or compare income-producing properties.

Formula:

Cap Rate = NOI / Purchase Price or Market Value

Example:

• NOI: $350,000

• Purchase Price: $5,000,000

• Cap Rate = 7%

What Cap Rates Tell You:

• Lower Cap Rate = lower risk, higher price

• Higher Cap Rate = higher risk, lower price

Market Ranges:

Property Type | Cap Rate Range

• Office | 4.5% – 6.0% (although not lately!)

• Industrial | 5.0% – 6.5%

• Retail Strip Mall | 6.5% – 8.0%

• Value-Add Assets | 7.5% – 10%

Cap Rate Pitfalls:

• Overreliance on pro forma NOI

• Not adjusting for property condition or lease strength

Tip: Use Cap Rates from comparable properties in similar submarkets to benchmark your deal.

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3. Debt Service Coverage Ratio (DSCR)

DSCR helps lenders determine if a property generates enough income to pay its debt obligations.

Formula:

DSCR = NOI / Annual Debt Service

Example:

• NOI: $240,000

• Annual Debt: $141,000

• DSCR = 1.70x

Lender Benchmarks:

Asset ClassMinimum DSCRMultifamily1.20xOffice1.25xRetail1.30xHospitality1.40x+

What DSCR Tells You:

• 1.00x = break-even

• < 1.00x = not covering debt

• 1.20x = generally acceptable

Best Practices:

• Stress test DSCR at lower NOI

• Account for rising interest rates on variable loans

Mistakes to Avoid:

• Using unadjusted NOI (e.g., without reserves or stabilized income)

• Failing to check for lender-specific DSCR covenants

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4. Loan-to-Value Ratio (LTV)

LTV measures the loan amount compared to a property’s appraised or purchase value. It’s used by lenders to gauge borrower risk.

Formula:

LTV = (Loan Amount / Property Value) × 100

Example:

• Loan: $1,500,000

• Value: $2,000,000

• LTV = 75%

Typical LTV Limits by Asset Type:

Asset Class | Max LTV

• Multifamily | 75% - 80%

• Office | 65% - 75%

• Retail | 65% - 70%

• Special Use | 60% - 65%

Why It Matters:

• Higher LTV = higher risk for lenders

• Impacts interest rate, loan terms, and cash needed

Tips:

• Consider alternative valuations (e.g., liquidation value)

• Watch out for "as-is" vs. "as-stabilized" LTV confusion

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5. Debt Yield

Debt Yield shows the lender how quickly they'd recoup their investment if they had to take over the property.

Formula:

Debt Yield = (NOI / Loan Amount) × 100

Example:

• NOI: $1,000,000

• Loan: $10,000,000

• Debt Yield = 10%

Benchmark Minimums:

Asset Type | Debt Yield

• Office | 10% - 12%

• Retail | 9% - 11%

• Multifamily | 7% - 9%

Why It Matters:

• Offers a "pure" view of income vs. debt

• Less sensitive to interest rate changes

Best Practices:

• Use Debt Yield alongside DSCR for fuller picture

• Know that lenders may prefer this over LTV in volatile markets

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6. Internal Rate of Return (IRR)

IRR estimates the annualized return on an investment over its full holding period, factoring in the time value of money.

Definition: IRR is the discount rate that sets the Net Present Value (NPV) of future cash flows to zero.

What IRR Includes:

• Yearly cash flow

• Sale proceeds/appreciation

• Initial investment

Example:

• Invest: $3.8M

• Hold: 5 years

• Leveraged IRR: 15.29%

IRR - Partitioned:

Source of Return | Contribution

• Year 1 Cash Flow | 6%

• NOI Growth | 15%

• Appreciation/Exit | 45%

• Principal Paydown | 34%

Best Use Cases:

• Comparing multiple investments

• Evaluating hold vs. sell scenarios

• Joint venture performance benchmarks

Pitfalls:

• Over-optimistic sale price assumptions

• Ignoring sensitivity to hold period changes

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7. Operating Expense Ratio (OER)

OER measures how much of a property’s income goes to operating expenses. It’s a key indicator of efficiency.

Formula:

OER = (Operating Expenses / Gross Operating Income) × 100

Example:

• Expenses: $850,000

• Income: $2,000,000

• OER = 42.5%

Typical Ranges:

Property Type | OER Range

• Industrial | 15% - 25%

• Multifamily | 35% - 45%

• Office | 35% - 55%

• Retail | 60% - 80%

Tips to Lower OER:

• Audit utility usage and vendor contracts

• Reduce turnover and associated make-ready costs

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Final Thoughts

Mastering these metrics gives you the toolkit to evaluate risk, estimate returns, and communicate effectively with partners, investors, or lenders. But remember—real estate is nuanced. No single number can make or break a deal.

Use these metrics in tandem, apply conservative assumptions, and always verify your data. Doing so will lead to smarter investments and fewer surprises.

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