How to Underwrite a Commercial Real Estate Deal, Step by Step

Before you request financials or schedule a tour, do a quick sanity check with whatever's in the listing:

• Price per unit / per square foot: How does it compare to recent comparable sales ("comps" — recent closed sales or leases of similar nearby properties used as pricing benchmarks) in the same submarket? Wildly above comps needs a strong justification (value-add upside, irreplaceable location); wildly below comps is often a red flag (deferred maintenance, legal issues, distressed seller).
• Implied cap rate at asking price: If the listing states an NOI, does the resulting cap rate look plausible for this property type and market tier? (See our Cap Rate Benchmarks Guide for typical ranges.)

If it clears this quick screen, move forward. If not, don't waste time requesting a full financial package on a deal that's obviously mispriced.

Ask the seller/broker for a trailing-12 (T-12 — an income and expense statement showing actual monthly operating performance over the past 12 months), a current rent roll (the unit-by-unit or suite-by-suite schedule of tenants, lease terms, contracted rents, and vacancies), and (ideally) 2-3 years of historical operating statements. Then don't just accept the bottom-line NOI — reconstruct it using the method in our How to Estimate NOI guide, normalizing for owner add-backs, below-market management fees, and any gaps between the rent roll and actual collections.

With a defensible NOI in hand, run the numbers that actually drive your decision:

• Cap Rate: Does the going-in yield make sense for this asset class and market tier?
• Cash-on-Cash Return: What's your actual return on the cash you're putting in, factoring in your realistic financing terms?
• DSCR: Will a lender's minimum threshold (typically 1.20–1.25) actually be met at your target loan amount — or does this deal only work with an unrealistically small loan?
• Break-Even Ratio: How much cushion do you have before vacancy or rising expenses put you underwater?

If any of these come back thin, that's not automatically a dealbreaker — but it tells you exactly where your risk is concentrated and what needs to improve (price, financing terms, or operational upside) for the deal to work.

Run your key ratios again under a less favorable scenario — vacancy up 3-5 points from your base case, a modest increase in operating expenses, and (if you're not locking a fixed rate) an interest rate 50-100 bps (basis points, where 100 bps = 1.00 percentage point) higher than today's quote. If the deal still "pencils" (industry shorthand meaning the numbers still work and meet your cash flow and debt-coverage targets when calculated) reasonably under a stress case, that's a much stronger signal than a deal that only works if everything goes exactly as planned.

To see how all pieces link together, examine the full underwriting walkthrough for the 24-unit apartment building introduced in our NOI Estimation Guide:

• Acquisition Terms: Purchase price of $2,800,000 ($116,667/unit).
• Verified Net Operating Income: Gross potential rent of $336,000 minus 5.0% normalized vacancy ($16,800) leaves $319,200 EGI. Deducting normalized operating expenses of $92,000 gives an in-place NOI of $227,200.
• Going-In Cap Rate: $227,200 ÷ $2,800,000 = 8.11% (well aligned with Class B multifamily benchmarks).
• Commercial Mortgage Financing: Sized at 75% LTV = $2,100,000 senior debt at 6.50% interest with a 25-year amortization schedule. Monthly payment is $14,179 ($170,152 annual debt service).
• Lender DSCR Compliance: $227,200 NOI ÷ $170,152 ADS = 1.34x DSCR (comfortably exceeding the lender's 1.25x minimum requirement).
• Invested Equity & Cash-on-Cash Return: 25% down payment ($700,000) plus $56,000 in closing costs and immediate working reserves (2.0% of purchase price) = $756,000 total cash out of pocket. Net annual pre-tax cash flow = $227,200 − $170,152 = $57,048. Cash-on-Cash Return = $57,048 ÷ $756,000 = 7.55%.
• Break-Even Safety Cushion: (OpEx $92,000 + ADS $170,152) ÷ $319,200 EGI = 82.13% Break-Even Ratio (78.0% Break-Even Occupancy). Physical occupancy can drop from 95% down to 78% before debt service default occurs.
• Stress Test (+100 bps Interest Shock): If loan rate closes at 7.50%, debt service climbs to $186,226 ($15,519/month); DSCR tightens to 1.22x; cash flow compresses to $40,974 (5.42% CoC). The asset remains self-sustaining with positive distributions even under rising rate conditions (Note: This rate-only stress test maintains 5% baseline vacancy; if vacancy simultaneously rises to 10%, NOI compresses to $210,400 and DSCR falls to 1.13x as modeled in our Deal Analyzer).

Numbers alone don't close a deal safely — verify the physical and legal condition of the asset:

• Property condition assessment: A professional inspection covering roof, HVAC, structural, and major systems — budget for anything flagged as near end-of-life.
• Title review: Confirm there are no liens, easements, or title defects that could complicate closing or future resale.
• Environmental review (Phase I ESA): Particularly important for industrial and older commercial properties with any history of fuel storage, dry cleaning, or manufacturing use.
• Zoning and permit compliance: Confirm the current use is legally permitted and that any planned renovations or expansions are actually allowed under current zoning.
• Lease abstract review: For multi-tenant properties, actually read (or have your attorney read) the underlying leases — don't rely on a summary rent roll alone, which can miss early termination rights, below-market renewal options, or tenant-favorable co-tenancy clauses.

Get an actual term sheet from a lender (not just a rough rate quote) before you're too far into the process — the specific DSCR, loan-to-value, and amortization terms you actually qualify for can meaningfully change your Cash-on-Cash and Break-Even numbers from Step 3.

Bring it all together: does the risk-adjusted return justify the price, given what you found in due diligence and the realistic financing you can actually secure? A deal that looked good on the initial screen but reveals meaningful issues in diligence should be repriced (renegotiate) or walked away from — not forced through because you've already invested time in it.