Common CRE Loan Covenants Explained
Commercial real estate (CRE) loans come with rules called covenants that borrowers must follow. These covenants protect both lenders and borrowers by reducing financial risks and ensuring the loan performs as expected. Here's what you need to know:
Two Main Types of Covenants:
Affirmative Covenants: Actions borrowers must take (e.g., maintaining insurance, submitting financial statements).
Negative Covenants: Actions borrowers cannot take (e.g., taking on more debt, selling assets without approval).
Key Financial Metrics:
Debt Service Coverage Ratio (DSCR): Measures how well property income covers debt payments. Lenders prefer a DSCR of 1.20–1.40.
Loan-to-Value Ratio (LTV): Compares loan amount to property value. Lower LTVs (below 80%) are safer and lead to better loan terms.
Net Worth and Liquidity Requirements: Borrowers often need a net worth equal to the loan amount and liquidity of 10% of the loan value.
Staying Compliant:
Covenant compliance isn’t just about avoiding penalties - it’s about building trust and securing better loan terms. By understanding these rules and using modern tools, you can manage your CRE loans effectively.
Understanding Commercial Loan Covenants - Breaking Down 6 of the Most Common Used Loan Guardrails!
2 Main Types of CRE Loan Covenants
Commercial real estate (CRE) loan covenants are generally divided into two categories: affirmative covenants, which outline actions borrowers are required to take, and negative covenants, which restrict specific activities. Tyler Scott, Senior Account Manager at BDC, puts it simply:
“Cash is king, and if you run into a cash flow shortage, you can run into trouble quickly. A covenant is really there to keep some checks and balances in place and to keep businesses healthy”
This classification provides the foundation for understanding how covenants work and how they connect to financial metrics.
Affirmative Covenants
Affirmative covenants, also referred to as positive covenants, require borrowers to meet specific obligations to maintain their operations and ensure transparency with lenders. These obligations often include maintaining proper insurance, submitting regular financial statements, complying with legal requirements, and keeping accurate records [4].
For instance, Bluegrass Capital Partners had to provide quarterly non-audited financial statements for the Greenbrook Village Center project. This requirement allowed lenders to monitor the property's financial health and address potential issues early on [8]. It’s important to note that failing to comply with these covenants can result in a technical default, even if the borrower is current on loan payments [1].
While affirmative covenants focus on required actions, negative covenants serve to limit certain behaviors.
Negative Covenants
Negative covenants are designed to restrict borrowers from taking specific actions without the lender’s approval. These restrictions protect the lender’s security interest and safeguard the borrower’s financial stability. Common examples include limits on taking on additional debt, selling assets, issuing dividends, or making significant business changes [6]. In one case, Bluegrass Capital Partners was prohibited from incurring additional secured debt for the same project [8].
Breaching a negative covenant can result in immediate default, allowing lenders to demand full repayment or initiate foreclosure [6]. Real-world cases illustrate the serious consequences of such breaches. For example, J. Crew’s decision to transfer key intellectual property outside the borrower group to secure additional debt contributed to its eventual bankruptcy. This led to the creation of "J. Crew blocker" covenants to prevent similar situations [7]. Another case involved Serta Simmons Bedding’s 2020 "uptier" debt restructuring, which was overturned by the U.S. Court of Appeals for the Fifth Circuit after it was ruled that the company violated its credit agreement by unfairly prioritizing certain lenders [7]. Additionally, between March 2017 and March 2022, lenders of North American first lien debt faced losses, with recoveries ranging from 62% to 71% of the original principal [5].
Together, affirmative and negative covenants establish clear expectations for borrowers while reducing risks for lenders, ensuring a balanced and secure lending environment.
Most Common Financial Covenants
After covering affirmative and negative covenants, let’s dive into the financial benchmarks that play a critical role in commercial real estate (CRE) lending. These benchmarks give lenders clear metrics to evaluate both the borrower's financial health and the property's ability to generate consistent income. These metrics go far beyond just tracking payment history - they offer a comprehensive view of financial stability. Below are some of the most commonly used financial covenants in CRE lending.
Debt Service Coverage Ratio (DSCR)
The Debt Service Coverage Ratio (DSCR) measures how well a property’s annual net operating income (NOI) can cover its annual debt payments. This metric is a cornerstone of CRE lending and provides insight into whether a property is generating enough income to meet its financial obligations [10]. A DSCR of 1.0 means the property’s income exactly matches its debt payments, leaving no room for error [10].
Lenders generally require a DSCR between 1.20 and 1.40 to minimize the risk of default [12]. However, a DSCR above 1.25 is often seen as ideal [10]. For properties considered higher risk - like retail spaces or special-purpose buildings - lenders may push for a DSCR range of 1.30 to 1.50 [12]. Falling below the agreed-upon DSCR threshold can trigger lender interventions, so borrowers need to stay aware of their lender’s specific DSCR requirements and ensure they maintain compliance [11][13].
Loan-to-Value Ratio (LTV)
Another key metric in CRE lending is the Loan-to-Value (LTV) ratio, which compares the loan amount to the property’s appraised value. A lower LTV ratio signals less risk for the lender, which can lead to better loan terms and higher chances of approval [14]. Generally, lenders offer the most favorable rates when the LTV is 80% or lower, while LTVs exceeding 95% are often deemed unacceptable [15]. Higher LTV ratios usually come with stricter terms, higher interest rates, and may require additional guarantees or insurance [14].
LTV preferences can vary depending on the property type, as shown below [16]:
Borrowers looking to improve their LTV ratio can save for a larger down payment, which not only reduces the ratio but also often results in better loan terms, such as lower interest rates and fewer fees [14][15].
Personal and Net Worth Requirements
In addition to property-based metrics, lenders often impose guarantor requirements to further secure their loans. Many CRE loans include personal guarantees, making the financial strength of the guarantor a critical factor in loan approval and compliance.
“Whether it’s a recourse or non-recourse loan, acquisition, refinance, or new development, the sponsor signing the loan must meet minimum net worth and liquidity requirements set forth by the lender.”
Lenders typically expect the guarantor’s net worth to equal or exceed the loan amount [18]. They also require liquidity - cash or marketable securities - amounting to at least 10% of the loan value [18]. For construction loans, liquidity requirements are often higher due to the increased risk of cost overruns [18]. Lenders also examine the guarantor’s credit history, income, and assets. Factors like past court judgments, tax liens, or foreclosures can significantly reduce approval chances for business owners [17].
Borrowers can sometimes meet these stringent requirements by pooling resources with other sponsors involved in the deal [18]. To boost approval odds, borrowers should maintain a strong credit score, provide detailed financial documentation, and consider offering additional collateral or bringing in a qualified co-signer when needed [17][18].
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How to Stay Compliant with Loan Covenants
Once affirmative and negative covenants are established, staying compliant becomes crucial for maintaining a strong relationship with your lender. A breach of these covenants can lead to serious consequences, such as higher interest rates, additional fees, accelerated loan payments, or even foreclosure. To avoid these outcomes, it’s essential to adopt a structured approach to monitoring, reporting, and maintaining open communication with your lender.
Compliance Strategies That Work
At the heart of covenant compliance lies consistent monitoring. Laura Pop-Badiu, Senior Creative Writer at CommercialEdge, underscores this point:
“The cornerstone of effective debt management is the consistent monitoring of loan covenants”
This means keeping a close eye on your financial metrics - not just during quarterly reporting periods, but on an ongoing basis.
To stay organized, maintain a well-structured repository of loan agreements, financial statements, and compliance records. This helps ensure you don’t miss critical deadlines or thresholds [3].
Consider using software to automate covenant tracking. Tools like Yardi’s Debt Manager, for example, offer real-time visibility into financial performance and send automated alerts when you approach covenant thresholds. In February 2025, Yardi highlighted the efficiency of this system in helping borrowers stay ahead of potential issues [3].
Develop financial models that track both current and projected covenant metrics. As Hall Render advises:
“For all of these strategies, the earlier you take action, the better. For this reason, among others, it is imperative that borrowers understand and closely monitor their covenant compliance on an ongoing basis.”
Proactive communication is another key piece of the puzzle. By keeping your lender informed, you demonstrate a commitment to the loan relationship. Additionally, leveraging asset-level budget data can help you identify risks before they escalate.
If monitoring and adjustments aren’t enough to maintain compliance, it’s important to take the initiative by discussing waivers or modifications with your lender.
Getting Waivers or Modifications
When compliance becomes difficult, reaching out to your lender early is critical - don’t wait until after a breach occurs. If your lender isn’t able to provide the relief you need, refinancing may be an option to consider as a last resort.
Understanding the hierarchy of covenant breaches can help you prioritize negotiations. For instance, lenders often see leverage covenant breaches as less severe compared to fixed charge coverage breaches, while payment defaults are considered the most serious [21].
During waiver negotiations, offering additional security - such as extra collateral, a borrowing base, or personal guarantees - can help reassure your lender. Providing detailed cash flow projections can further demonstrate your ability to manage temporary challenges [21].
Kent Kirby, Director of Advisory Services at Abrigo, stresses the importance of clear agreements:
“Waivers are fine, but they need to be time-bound and need to be very specific.”
When requesting waivers, be sure to propose specific timeframes and conditions rather than seeking open-ended relief.
If modifications are necessary, come prepared with thorough documentation. Review your loan agreements to identify the provisions that need adjustment. Submit updated income and expense budgets that outline your plan to regain compliance [19] [23]. Finally, establish a system to monitor your progress on all financial covenants, showing your lender that you’re committed to transparency and accountability [22].
Using Tools to Track Financial Covenants
Keeping a close eye on financial covenants is essential for maintaining healthy relationships with lenders. Relying on spreadsheets for this task, however, introduces unnecessary risks for commercial real estate borrowers. With nearly 70% of banks still using spreadsheets and manual methods for covenant tracking [24][27], and over 38% of middle market companies unknowingly violating loan agreements [26], it’s clear that specialized financial analysis platforms can make a huge difference.
Automated tracking tools offer real-time insights into financial performance and send timely alerts when thresholds are at risk of being breached [3].
Benefits of Financial Analysis Platforms
Platforms designed for financial analysis bring everything together - loan agreements, financial data, and compliance records - into one centralized system. This approach minimizes the chance of missing critical lender requirements and encourages smoother collaboration among team members [3].
Automation is a game-changer here. These platforms ensure that important metrics like debt service coverage ratios, loan-to-value ratios, and cash flow statements are updated consistently without the need for manual input [3]. This not only reduces human error but also provides lenders with accurate, up-to-date information, helping to build and maintain trust.
Take BankStride as an example. This platform simplifies the process by automatically scheduling and managing tasks related to loan agreements. For instance, BankStride handles monthly requests for accounts receivable and payable listings, inventory analyses, and borrowing base certificates. It also reminds banking teams to test various financial ratios, with all results compiled into detailed reports that can be generated in seconds [24].
“BankStride saves time by delivering essential information.”
Another example is Cardo AI's automated covenant monitoring system. When a private credit lender extended a $50 million loan to a mid-sized manufacturing company with a Net Leverage covenant capped at 4.5x EBITDA, the borrower uploaded their financials directly into the platform. The system processed the data instantly, calculated key metrics, and updated covenant levels in real time. When the Net Leverage exceeded 4.5x, an alert was sent to the lender, allowing them to act quickly - whether that meant requesting a waiver, adjusting loan terms, or securing additional collateral [25].
These platforms also make it easier to share compliance reports directly with lenders. This proactive approach reduces risks and shows a commitment to maintaining strong loan relationships [3]. By automating compliance monitoring, businesses can focus more on strategy and less on tedious manual tasks.
Key Features of CoreCast
The Fractional Analyst takes these benefits to the next level with its CoreCast platform, which is designed to simplify compliance for commercial real estate professionals. CoreCast consolidates workflows and data streams into a single, unified system [28].
One standout feature of CoreCast is its ability to automatically gather and standardize data from multiple sources, ensuring consistent and reliable reporting [28]. The platform also includes a live operating dashboard that supports decision-making across acquisitions, asset management, and portfolio strategies, offering real-time insights into covenant compliance.
CoreCast doesn’t stop at tracking. Its advanced algorithms create investment memos and asset management reports, saving time and ensuring accuracy - two factors that are critical for maintaining lender confidence [28]. Instead of spending hours compiling reports, users can focus on analyzing data and making informed decisions.
“CoreCast isn’t just another software tool - it’s the operating system for modern real estate investment and asset management.”
The platform’s impact is clear. A Director of Acquisitions at a REIT shared that CoreCast's Pipeline Tracker reduced deal slippage by 30% over two quarters [28]. Another client noted that tasks like consolidating financials, which previously took hours, now take just minutes [28].
In addition to its software, The Fractional Analyst offers tailored financial analysis services, such as detailed underwriting, operational insights, market research, and investor reporting [29]. These services complement the platform’s automation by providing expert support for more complex scenarios, like covenant negotiations or modifications.
For commercial real estate professionals, The Fractional Analyst delivers both the tools and expertise needed to manage covenant compliance effectively, maintain strong lender relationships, and minimize risks along the way.
Conclusion
Handling CRE loan covenants involves more than just meeting compliance requirements - it’s a key part of fostering strong borrower-lender relationships. These covenants act as safeguards for financial institutions, helping them manage credit risk, particularly when borrowers encounter difficulties that might affect their ability to repay.
Recent data sheds light on trends in covenant management. According to an Abrigo survey, 57% of bankers stated their institutions require covenants on term loans, and nearly one-third of lenders have tightened their covenant requirements in recent quarters[2]. Despite this, enforcement remains a challenge. Only one in four banks considers their enforcement practices strict, even though three out of four actively monitor compliance[2]. This gap between monitoring and enforcement highlights both the challenges and opportunities in covenant management.
Addressing this enforcement gap is crucial. Effective covenant management, supported by open communication between lenders and borrowers, can help avoid penalties, defaults, or even foreclosure[3].
To succeed, institutions need a clear understanding of covenants, strong financial monitoring processes, and consistent communication with borrowers[30]. Modern tools, like The Fractional Analyst's CoreCast platform, make this process easier by automating data collection, standardizing calculations, and offering real-time insights. These features ensure borrowers stay compliant while reducing the administrative burden on lenders.
When done right, covenant management delivers significant benefits. It strengthens financial discipline, supports smarter decision-making, and builds trust between borrowers and lenders. In a market where higher risks demand responsible borrower behavior, proactive covenant management isn’t just a necessity - it’s an advantage that can lead to better loan terms and enduring partnerships[2].
FAQs
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Violating a negative covenant in a commercial real estate (CRE) loan can lead to serious repercussions. Lenders often treat such breaches as loan defaults, which might trigger financial penalties, demands for immediate repayment, or even legal action. In extreme scenarios, the lender could seize the collateral or begin liquidation proceedings to recover their investment.
To steer clear of these risks, it's crucial to thoroughly understand and adhere to all the loan covenants detailed in your agreement. If a breach seems inevitable, reaching out to your lender early can open the door to discussions and potential solutions that might help lessen the impact.
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Borrowers can use technology to ensure compliance with commercial real estate (CRE) loan covenants by adopting tools that automate financial tracking and reporting. These platforms keep an eye on critical metrics like debt service coverage ratios (DSCR) or loan-to-value (LTV) thresholds in real time, sending alerts if there’s a risk of breaching any covenants.
With automated solutions in place, borrowers can improve reporting accuracy, minimize compliance risks, and have clear oversight of their financial responsibilities. These tools empower borrowers to tackle potential issues early, helping them stay on top of their obligations and maintain strong lender relationships.
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Borrowers looking to improve their Loan-to-Value (LTV) ratio have a few practical options to consider:
Put down a larger down payment: Increasing your initial payment reduces the amount you need to borrow compared to the property's value.
Pay off more of the loan principal: Making extra payments directly toward the principal lowers your remaining loan balance.
Boost the property's value: Upgrades or renovations can raise the appraised value of your property, which helps improve the ratio.
A better LTV ratio could open the door to more attractive loan terms, like lower interest rates and improved financing opportunities.