How to Underwrite a Commercial Real Estate Deal (Step-by-Step)

Before you touch a spreadsheet, collect everything you need from the broker or seller. At minimum, your due diligence package should include the current rent roll with all lease abstracts, trailing 12-month operating statements (ideally trailing 3 years), property tax bills and assessments, insurance certificates and premium history, CAM reconciliations, copies of all executed leases, capital expenditure records, and a Phase I environmental report.

For larger deals, also request tenant estoppel certificates (confirming tenants agree with the stated lease terms), an ALTA survey, property condition assessment, title commitment, and zoning verification. Every number in your underwriting model should trace back to a source document — not to a broker’s marketing flyer.

Enter every suite individually with the tenant name, suite number, square footage, lease type (NNN, gross, or modified gross), base rent per square foot, lease commencement date, lease expiration date, and any rent escalation schedule. For vacant suites, enter the market rent assumption you’ll use for stabilization projections.

From the rent roll, calculate: total in-place gross rent, in-place occupancy rate, weighted average lease term (WALT), annual rent per square foot by suite, and lease expiration schedule by year and quarter. The rent roll drives everything downstream — NOI, cash flow projections, DSCR, and valuation — so accuracy here is non-negotiable.

Cross-reference every lease term against the actual signed lease document. Broker-provided rent rolls frequently contain errors in expiration dates, rental rates, or lease type classifications that can materially affect your underwriting.

Build your expense model using actual trailing expenses as the baseline, adjusted for any one-time items or owner-specific costs. Standard expense categories include property taxes, insurance, CAM/common area maintenance, repairs and maintenance, management fees (even if self-managed — lenders and investors underwrite a fee regardless), utilities (for gross lease properties), and reserves for replacements.

Express each expense on a per-square-foot basis and compare against market benchmarks for the asset class and geography. If the owner reports property taxes of $1.50/SF in a market where comparable properties pay $3.00/SF, the property may be due for a tax reassessment at the sale price — which would nearly double that expense line. Similarly, if insurance seems low, get a quote for the actual coverage you’d carry.

For NNN properties, the tenant pays most operating expenses directly. Your underwriting should still account for landlord-retained expenses like structural repairs, roof maintenance (if not passed through), and management overhead.

With your rent roll and expense model complete, calculate net operating income for both the in-place and stabilized scenarios. Then layer in your financing assumptions — loan amount, interest rate, amortization period, and any interest-only term — to derive annual debt service.

From these inputs, calculate your core underwriting metrics: going-in cap rate (in-place NOI ÷ purchase price), stabilized cap rate (stabilized NOI ÷ total cost basis), DSCR (NOI ÷ annual debt service), cash-on-cash return (annual pre-tax cash flow ÷ total equity invested), loan-to-value ratio, debt yield (NOI ÷ loan amount), and price per square foot.

These metrics should be calculated on both an in-place and stabilized basis. The difference between the two tells the story of the deal: are you buying a stabilized cash-flowing asset, or are you buying a value-add opportunity that requires capital and execution to reach its potential?

Project monthly or annual cash flows across your hold period — typically 5, 7, or 10 years. Each period should account for lease expirations and re-leasing assumptions (market rent, downtime between tenants, tenant improvement costs, leasing commissions), rent escalations on existing leases, expense growth (typically 2–3% annually), and vacancy reserve.

For each lease that expires during the hold period, model a re-leasing scenario: how many months of downtime, what tenant improvement allowance you’ll offer, what leasing commission you’ll pay, and at what rental rate the space re-leases. These assumptions drive the volatility in your cash flow projections and are where most underwriting errors occur.

The cash flow schedule should show gross income, vacancy loss, effective gross income, operating expenses, NOI, debt service, and pre-tax cash flow for each period — giving you a complete picture of the deal’s financial trajectory.

Estimate the property’s sale value at the end of your hold period by applying an exit cap rate to the projected NOI in the exit year. The exit cap rate is typically 25 to 75 basis points higher than your going-in cap rate — accounting for the fact that the building will be older and may face different market conditions.

Deduct selling costs (typically 2–3% of the sale price), any remaining loan balance, and prepayment penalties. The result — combined with cumulative operating cash flow — gives you total equity return. From there, calculate your equity multiple (total distributions ÷ initial equity) and internal rate of return (IRR).

Run this analysis at multiple exit cap rates (e.g., going-in minus 25bps, going-in flat, going-in plus 50bps, going-in plus 100bps) to understand how cap rate movement affects your returns. If the deal only works with cap rate compression, you’re making a market bet, not an income investment.

Before finalizing your underwriting, run stress scenarios: what happens if your largest tenant vacates, if interest rates rise 200 basis points at refinancing, if market rents decline 10%, or if the hold period extends two years beyond plan? A deal that survives these stress tests is robust. One that breaks is fragile — and fragile deals produce the biggest losses in commercial real estate.

Your final output should be a complete investment memo: property overview, rent roll summary, financial model, return metrics, risk assessment, stress-test results, and a clear recommendation. This is the document that you, your partners, and your lenders will use to make the investment decision.