How to Analyze a Commercial Real Estate Deal (Like a Lender Will)

Residential buyers fall in love with kitchens. Commercial buyers who fall in love with anything other than the numbers get expensive educations. Every commercial deal — a fourplex, a strip retail center, a small warehouse — is analyzed the same way: verify the income, honesty-check the expenses, and test whether the debt survives a bad year. Here's the sequence, in the order a lender's underwriter will run it.

Step 1: Rebuild the NOI from scratch

Net operating income = actual collected income minus actual operating expenses, before any mortgage. Rebuild it yourself: start from the rent roll (every unit, actual rent, lease end date), subtract a real vacancy factor even if it's full today, then load every expense — taxes at your post-sale reassessed value (not the seller's old bill), insurance at a fresh quote, management even if you'll self-manage, repairs, and reserves. The two most common pro forma omissions are management and reserves, which together quietly inflate NOI by 12-15%.

Step 2: Put the cap rate in context

Cap rate = NOI ÷ price. It's the deal's unlevered yield — and it only means something in context. A 7% cap is cheap for a stabilized apartment building in a growth market and expensive for a vacant-anchor retail strip. Compare within the same market, property type, and risk class, and always ask why the seller's cap is above market: it's usually deferred maintenance, a lease about to expire, or income that won't survive your ownership.

Step 3: Test the debt — DSCR decides

Debt service coverage ratio = NOI ÷ annual mortgage payments. Lenders generally want 1.20-1.25x or better: for every dollar of mortgage, the building earns at least $1.25. Below that, the loan shrinks or dies — which is why a deal that 'works' at asking price often can't actually be financed at asking price. Run DSCR at today's rates and again at rates 1% higher; if the deal only pencils at perfect financing, it doesn't pencil.

Step 4: Due diligence that actually kills bad deals

• Leases, not the rent roll summary: read every lease for termination rights, renewal options at fixed rents, and co-tenancy clauses.
• Estoppel certificates from tenants — the document where tenants confirm what they actually pay and claim (or disclaim) landlord defaults.
• Trailing-12 and year-end financials against bank statements; income that can't be traced to deposits doesn't exist.
• Physical: roof, structure, HVAC, environmental Phase I. Capex you find after closing is capex you bought at full price.
• Zoning, permitted use, and parking ratios — especially if you plan any change of use.