Commercial Real Estate Underwriting: Screen the Deal First, Then Build the Full Model

What underwriting means, on both sides of the deal

On the equity side, underwriting is deciding what a property is worth to your fund: projecting income and expenses, deciding what you will pay, how you will finance it, what you will sell it for, and whether the return clears your hurdle. It ends in a recommendation to an investment committee.

On the debt side, underwriting is the lender's version of the same question: can this property's income service the loan, and is the loan small enough relative to value to protect the lender if it can't? Lenders size loans on loan-to-value, debt service coverage ratio (NOI over annual debt service, often required at 1.20x to 1.35x) and debt yield (NOI over loan amount). On a $26,000,000 loan against $2,400,000 of NOI, the debt yield is 9.2% and, at a 6.5% rate on a 30-year amortization, the DSCR is 1.22x. Our debt yield vs DSCR post works through both, and the lending page covers how origination teams run this at volume.

The rest of this guide is written from the equity side. Lenders will recognize most of it.

Why the screen and the full model are different jobs

Most guides describe one process that begins with the OM and ends with the IC memo. In practice there are two, and the second happens to a small fraction of the deals that go through the first.

The screen answers: is this deal worth a week of an analyst's time? It uses the OM, the firm's buy box and about 5 numbers. It takes minutes. Its output is pass or pursue.

Full underwriting answers: what should we pay, and why? It uses the rent roll, the T12, comps, the firm's model and the diligence process. It takes days or weeks. Its output is a model, a list of open items and a memo.

Running the full process on every deal that arrives is how analysts end up building models for deals no one was going to buy. Running the screen too loosely is how firms miss the deal that fit. Keeping the two separate is the organizing idea of this guide.

Stage 1: the screen

Write the buy box down

A buy box is the set of criteria a deal must meet to be worth pursuing. Most firms have one in their heads. Fewer have it written down where an analyst can check a deal against it in 90 seconds.

Four dimensions cover most of it. Capital type: core, core-plus, value-add or opportunistic, which fixes the return you need. Sector: multifamily, industrial, office, retail, and the sub-types you won't do. Market: the metros and submarkets you are in, and the ones you'd enter. Size: minimum and maximum equity check.

Add the deal-level filters that drive automatic passes at your firm: no ground leases, no single-tenant buildings with under 5 years of term, nothing built before 1980, whatever yours are.

Pull 5 numbers from the OM

An OM is designed to be read in a particular order. For a screen, ignore it and go to 5 numbers. The how to read an offering memorandum post goes deeper on each.

1. Asking price, or the guidance if unpriced.
2. In-place NOI from the trailing 12 months, and the pro forma NOI the broker is quoting. Note the gap.
3. Going-in cap rate on in-place NOI. Compute it yourself; the cover figure is usually on pro forma.
4. Occupancy and WALT, from the rent roll summary.
5. Price per unit or per SF, against the last 3 comps you know in that submarket.

Those 5, against the buy box, decide most deals. A 5.2% going-in cap in a market where your passed deals cleared at 6.0% is a pass unless there is a specific story. A 70% occupied building is a pass for a core fund and a look for a value-add one.

Pass most of them, and keep what you pass

Most of what arrives gets passed on. That is the system working.

The passed deals are worth keeping, because each one is a data point: a price, an NOI, a cap rate, a rent per SF, in a market you care about. Six months later, when someone asks whether a 5.75% exit cap in that submarket is defensible, the answer is in the deals you passed on. Most firms lose this data because the pass happens in an email reply and nothing gets filed.

Stage 2: full underwriting, in order

The order matters. Each step feeds the next, and skipping to the returns page before the inputs are clean produces a model that has to be rebuilt.

1. Normalize the rent roll and the T12

Start with the two documents that describe what the building earns today.

The rent roll gives contract rent, lease dates, rollover and tenant concentration. Rebuild its totals yourself, read the notes column for free rent and holdovers, and strip out any "proposed" tenants. The commercial rent roll template post has a worked 10-tenant example.

The T12 gives collected income and actual expenses for the trailing 12 months. Normalize it: remove one-time items, add back expenses the seller has moved below the line, replace the seller's management fee and reserves with yours, and reconcile rental income to the rent roll. The two should tie after adjusting for free rent and mid-year lease starts. Where they don't, you have a question for the broker. See what a T12 is and how to normalize it.

2. Set market rents from comps

For every rollover in the hold period, you need an assumption about the rent the space re-leases at. That comes from lease comps in the submarket, your own portfolio if you have assets there, and the deals you have seen. Mark each lease to market so the upside and the downside are visible.

3. Operating assumptions

Vacancy and credit loss: a stabilized figure for the market, plus specific downtime on each known rollover (months vacant, free rent, leasing commission, tenant improvements). Rent growth: by year, defensible against the submarket's recent history. Expenses: grown by line item, with taxes reassessed on your purchase price, the one most often missed. Capital expenditures: immediate repairs from the property condition report plus an annual reserve per unit or per SF.

4. Capital assumptions

Purchase price and closing costs. Debt: loan amount, rate, amortization, term, interest-only period, and the lender's sizing tests (LTV, DSCR, debt yield) to confirm the loan is available. Exit cap rate and hold period, with the exit cap set against your own comps. The going-in vs exit cap rate post shows how 50 basis points on the exit cap of a $40,000,000 purchase moves the sale price by $3.6 million and the unlevered IRR by about 1.5 points.

5. Returns

The model now produces unlevered IRR, levered IRR, equity multiple, cash-on-cash yield by year, and the lender's DSCR and debt yield by year. Compare each to the fund's hurdle and the lender's covenants. A levered IRR that clears the hurdle only because the loan is interest-only for the whole hold is a finding, and the memo should say so.

6. Sensitivities

Run three at minimum: exit cap plus and minus 50 basis points, rent growth plus and minus 1 point a year, stabilized vacancy plus and minus 2 points. Show the IRR grid. If the deal only works in the base case, the sensitivities are the answer. Add a cap rate compression scenario if the market has moved a lot in the last 2 years.

7. Diligence items

List what the model assumes that has not been verified: lease estoppels, property condition report, environmental Phase I, title and survey, tax reassessment, insurance quotes, and tenant credit review for any concentration above 20% of rent. Each item gets an owner, a cost and a date, and the list goes into the memo as open items.

If an item comes back worse than the OM said, decide before the hard deposit whether to absorb it or ask for a retrade on price. Ask only for what diligence found that the OM didn't show. Brokers remember buyers who retrade on facts that were in the book.

The underwriting checklist

Copy this into whatever your team uses.

Screen (minutes)

• Buy box written down: capital type, sector, market, size, automatic passes
• Asking price or guidance
• In-place NOI and pro forma NOI, with the gap noted
• Going-in cap rate on in-place NOI, computed by you
• Occupancy and WALT from the rent roll summary
• Price per unit or per SF against 3 recent comps
• Decision: pass or pursue, with a one-line reason
• Passed deal filed with its numbers, by market

Documents (before the model opens)

• Current rent roll, dated within 30 days, totals rebuilt and tied
• T12 normalized and reconciled to the rent roll
• Lease abstracts for the top 3 tenants by rent
• OM saved with the deal record, cover cap rate noted as pro forma or in-place

Model (full underwriting)

• Market rents by space type, with comp source
• Rollover assumptions per lease: downtime, free rent, TI, commission
• Stabilized vacancy and credit loss
• Rent growth by year
• Expenses by line item, taxes reassessed on purchase price
• Capex: immediate repairs plus annual reserve
• Debt terms and lender sizing tests (LTV, DSCR, debt yield)
• Exit cap and hold period, with comps
• Returns: unlevered IRR, levered IRR, equity multiple, cash-on-cash, DSCR and debt yield by year
• Sensitivities: exit cap, rent growth, vacancy

Diligence and memo

• Open diligence items with owner, cost and date
• Assumptions page listing every input and its source
• IC memo drafted from the model, with the sensitivities grid

Want the screen half done when the OM lands? Start free

The assumptions an investment committee will challenge

Investment committees read the assumptions page before the returns page, and go to the same cells every time.

The exit cap, first. Expect "why is the exit below where we bought?" or "what did the last 3 trades in this submarket clear at?" Have the comps on the page.

Rent growth, second. A 4% annual growth assumption in a submarket that grew rents 1.5% a year over the last 5 years needs a reason specific to this building.

Vacancy, third. Committees know that a model's stabilized vacancy is often the number that was needed to hit the hurdle. Show the market figure and your downtime on each known rollover separately.

The expense ratio, fourth. A pro forma expense ratio well below the T12's raises the question of which expenses were cut and why the next owner gets to keep the savings.

Then the debt: whether the loan is available on those terms, what happens at maturity if it falls inside the hold, and what the DSCR looks like in the downside case.

The handoff into the IC memo

The memo is the model translated into a decision. It states the thesis in a paragraph, puts the returns next to the hurdle, shows the sensitivities grid, lists the open diligence items and asks for a specific approval: price, deposit, timeline.

The assumptions page is the bridge. If every input has a stated source (rent roll, T12, comp, lender term sheet, your judgment), the memo writes itself and the committee can trace any number back. If the inputs were typed in from memory, the memo gets defended instead of read. The investment committee memo template post has a structure to copy, and from offering memorandum to IC memo covers the timing.

Where Altrio fits

Altrio does the screen on arrival. It connects to the team's Gmail or Outlook, captures each deal a whitelisted broker sends, reads the OM, rent roll and T12, files the numbers into a deal record and scores the deal against the firm's buy box. The same deal sent by 3 brokers becomes 1 record with each email as a tab. Passed deals stay in the firm's comps, by market, with their deal-flow counts.

Full underwriting stays in the firm's own model; Altrio exports the deal record to Excel so the inputs reach your template without being retyped. For firms that want approvals, workflows and IC dashboards on top, Enterprise is the edition PGIM Real Estate, AEW and Hines run on. More on the screening side at deal sourcing and screening, on bringing the whole process into one place in centralize CRE underwriting, and on tooling for both stages in CRE underwriting software.