CRE 101 Series

1. 1. What is CRE?
2. 2. The T12
3. 3. NOI Explained
4. 4. Cap Rates
5. 5. Property Types
6. 6. How Properties Make Money
7. 7. Lease Structures
8. 8. Financing Fundamentals
9. 9. Key Investment Metrics
10. 10. Valuation Basics
11. 11. Reading a Rent Roll
12. 12. Pro Forma Rent
13. 13. Risk Profiles
14. 14. Due Diligence
15. 15. The Acquisition Process

In This Article

CRE Financing Fundamentals: A Beginner's Guide

CRE financing fundamentals are the metrics lenders and borrowers rely on to determine how much debt a commercial property can support, including LTV, LTC, and DSCR.

Almost every commercial real estate deal uses debt alongside equity. Before any of the numbers around a deal make sense, cap rate, DSCR, returns, it helps to understand the basic vocabulary of that debt.

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Why CRE Deals Use Debt

Leverage means using borrowed money to control a larger asset than an investor's own capital alone would allow. If a property costs $10,000,000 and a lender is willing to finance 65% of that, the investor only needs to bring $3,500,000 of their own equity to close the deal.

Used well, leverage can boost an investor's return on their own capital, since the returns generated by the whole property get concentrated onto a smaller equity base. Used poorly, it does the same thing in reverse, amplifying losses just as easily as gains. Leverage is a tool, not a guarantee, how it affects returns depends on the specific deal and how the debt is structured.

Common CRE Loan Types

Not all commercial real estate debt looks the same. A few types show up most often for the kind of acquisition deals this series is built around.

Permanent loans. Long-term financing for a stabilized, income-producing property, typically with terms of 5 to 10 years and amortization schedules stretching out further than that. This is the most common loan type for a property that's already leased up and performing.

Bridge loans. Short-term financing, usually 1 to 3 years, used for a property that isn't yet stabilized, think a value-add deal mid-renovation or mid-lease-up. Bridge loans typically carry higher interest rates than permanent loans, reflecting the higher risk of a property that isn't yet producing steady income. Once the business plan is executed and the property stabilizes, the bridge loan is usually refinanced into a permanent loan.

Agency debt. For multifamily specifically, Fannie Mae and Freddie Mac are major sources of permanent financing, often offering attractive long-term, fixed-rate terms. If you're underwriting a multifamily acquisition, learn to recognize agency debt by name even at a beginner level, since it's likely to come up as a financing option.

Loan Term vs. Amortization, and the Balloon Payment

Two numbers that sound similar but mean different things: the loan term and the amortization period.

Loan term is how long the loan is actually in place before it must be repaid or refinanced.

Amortization period is the schedule used to calculate the monthly payment, as if the loan were being paid down over that full period.

Here's where it gets confusing: these two numbers are often different. A common structure is a 10-year loan term with a 30-year amortization schedule. The monthly payment is calculated as if the loan will take 30 years to pay off, but the full remaining balance actually comes due after just 10 years. That remaining balance is called a balloon payment, and the borrower has to pay it off, sell the property, or refinance before it comes due.

This structure keeps monthly payments lower than a fully amortizing loan would, but it also means refinancing risk is a real part of nearly every CRE deal, not just an edge case.

Core Financing Concepts

A handful of ratios show up in nearly every CRE financing conversation. At this stage, the goal is to understand what each one means conceptually, the full sizing mechanics come later.

Loan-to-Value (LTV). The loan amount as a percentage of the property's value. An 80% LTV means the lender is financing 80% of the property's value, and the borrower is covering the remaining 20% with equity. A lower LTV means more equity in the deal and less risk for the lender.

Loan-to-Cost (LTC). The loan amount as a percentage of total project cost, rather than value. LTC matters more on value-add or development deals, where the purchase price alone doesn't capture the full cost of the business plan, renovation budgets and closing costs matter too.

Debt Service Coverage Ratio (DSCR). A measure of how much cushion a property's NOI provides over the loan payment. Conceptually, it's asking: does this property generate enough income to comfortably cover its debt payments, with some room to spare. The full sizing mechanics, and what a "good" DSCR actually is, are covered in more depth elsewhere on the site.

Recourse vs. non-recourse. This describes who's on the hook if the loan defaults. A recourse loan means the lender can pursue the borrower's other assets beyond just the property itself. A non-recourse loan limits the lender's claim to the property in most circumstances, but "non-recourse" rarely means zero personal exposure. Nearly every non-recourse loan includes carve-outs (sometimes called "bad boy" carve-outs) that can make a borrower personally liable in specific situations, like fraud, misrepresentation, environmental issues, or certain bankruptcy actions, and many loans also require a separate personal guaranty covering some of these carve-outs. The specific carve-outs and guaranty terms matter as much as the recourse/non-recourse label itself.

How Lenders Think About Risk

Lenders don't look at any one of these numbers in isolation. A loan typically gets sized around whichever constraint is tightest, and LTV, LTC, and DSCR are the three most commonly discussed, but they're not the only ones. Debt yield (NOI divided by loan amount), a lender's own minimum or maximum loan size, and lender-specific underwriting standards can all come into play too, and different lenders weigh these constraints differently. A deal might easily clear an 80% LTV test but still get a smaller loan because its NOI can't comfortably support the debt service a DSCR test would require, or because it falls short of a lender's debt yield threshold. Understanding that multiple constraints interact, rather than treating any single ratio, or even just three of them, as the whole picture, is the first real step toward thinking like a lender.

Common Mistakes

• Assuming more leverage is always better. Higher LTV means a smaller equity check, but it also means more risk, both a bigger required payment and less cushion if the deal underperforms.
• Confusing LTV and LTC. They sound similar, but LTV is based on value, LTC is based on total project cost, and they can produce meaningfully different numbers, especially on a value-add deal.
• Assuming "non-recourse" means zero personal exposure. Carve-outs and personal guaranties can make a nominally non-recourse loan carry real personal risk in specific situations, the details matter more than the label.

FAQ