Three tests, one answer

Start with the constant, not the rate

A commercial lender does not size a loan against an interest rate. It sizes against thedebt constant — annual debt service per dollar borrowed, which folds the rate and the amortisation into one number. At 6.35% over thirty years the constant is about 7.46%: every dollar borrowed costs 7.46 cents a year. At the same rate over twenty years it is 8.86%. The rate did not move; the loan you can carry fell by 16%.

That is why extending amortisation is often worth more than negotiating the coupon, and why a twenty-year amortisation on an older building quietly costs a sponsor more leverage than the quarter-point they spent a week arguing about.

Test one — loan-to-value

The loan is capped at a percentage of the lesser of purchase price and appraised value. Not the higher of. A contract above appraisal does not raise the loan; it raises the equity.

Cash-out lowers the cap, usually by five to ten points, because a borrower taking money off the table has less at risk than one leaving it in. This test binds on long-leased, low-leverage assets and rarely anywhere else.

Test two — debt service coverage

Underwritten net operating income divided by annual debt service. The floor is the whole negotiation: 1.20× on stabilised apartments, 1.30–1.45× on retail, 1.35–1.50× on office, 1.40× and up on operating assets like storage and hospitality.

The subtlety that catches people is which debt service. Most lenders test coverage on the amortising payment even when the loan pays interest-only for its first years, so interest-only improves your cash flow without improving your proceeds. A lender that sizes on the interest-only constant is making a real concession, and it should be identified as one.

Test three — debt yield

Net operating income divided by the loan amount. It contains no rate and no appraisal, which makes it the only sizing test that survives being wrong about either. At a 10% floor the loan is exactly ten times income; at 12% it is 8.33 times. Between those two floors sits a 17% swing in proceeds that no negotiation touches.

This is the test that decides most retail and nearly all office deals today, and it is the one sponsors most often have never heard of before their first term sheet.

Then the reserves come off

Coverage is tested on income after reserves, so reserves reduce the loan as well as the cash flow. On multifamily that means a per-unit replacement reserve; on retail and office it means a tenant improvement and leasing reserve sized off the rollover schedule. A file that ignores reserves overstates its own leverage by five to eight percent before anybody has argued about anything.