Underwriting

What we read, in the order we read it

The operating statement you send and the operating statement a credit committee reads are not the same document. Nothing about that is a trick — the adjustments are standard, predictable and almost never explained in advance. Here they are in advance.

Chordline underwrites nothing. This page describes how commercial underwriting generally works so the template has something real to say; no figure on it is a policy of any lender.

The gap between two NOIs

An owner’s net operating income is what the property earned. An underwriter’s net operating income is what a lender is prepared to believe the property will keep earning if the owner changes, the market softens, and the tax assessor notices the sale. The second number is almost always smaller, and the difference is made of eight adjustments.

  • Economic vacancy replaces physical vacancyConcessions, bad debt, model units and employee units come out of income even when the unit is occupied. This is the single largest source of the gap between an owner’s NOI and an underwriter’s.
    reduces NOI
  • A management fee is imposedThree to four percent of effective gross income, applied whether or not you pay one. A lender has to be able to hire a manager if it takes the property back.
    reduces NOI
  • Replacement reserves are deductedPer unit or per square foot, annually, before coverage is tested. Older stock carries a larger deduction.
    reduces NOI
  • Taxes are reassessedWhere the jurisdiction reassesses on sale, the tax line is underwritten at the new basis, not the seller’s. On a long-held property this can be the largest single adjustment in the file.
    reduces NOI
  • Non-recurring income is removedLease termination fees, insurance recoveries, legal settlements. Real money, but not income you can borrow against.
    reduces NOI
  • Above-market rent is cappedSpace expiring inside the loan term is underwritten at market, not at the passing rent. A tenant paying well over market is a rollover risk, not a strength.
    reduces NOI
  • Other income is taken at trailing actualsLaundry, parking, fees and utility reimbursements count, at what they actually collected, with at least six months of history.
    supports NOI
  • Documented contractual increases countA signed lease with a scheduled step is credited from the date it takes effect, not before.
    supports NOI

What makes a package read well

An underwriter who finds a surprise re-reads everything from the beginning. An underwriter who was told about it re-reads nothing. That difference is worth more than any covering letter.

  • Send system exports, not retyped summaries. A spreadsheet that does not tie to the accounting system starts a reconciliation nobody wanted.
  • Reconcile the rent roll to the December collections line yourself, before anyone else does.
  • Flag the non-recurring items and say what they were. Naming the ugly line is how the rest of the file gets believed.
  • Send the leases, not the abstracts, for anything material. Co-tenancy and exclusive clauses are read in full or not at all.
  • Say what the capital plan is and what it costs. A deferred roof is a reserve, not a discount, and it is better to price it than to hope.

Third-party reports

The appraisal, the Phase I environmental site assessment and the property condition assessment are ordered by the lender, paid for by the borrower, and cannot be influenced by either. They sit on the critical path of nearly every commercial closing. A recognised environmental condition in a Phase I usually leads to a Phase II, and a Phase II takes time nobody budgeted.

They are ordered after a term sheet is signed, not before, because nobody spends that money on a deal that has not agreed its structure.