🏢 The $1 Million CRE Loan Test: How Much NOI Do You Need at 7%, 8% & 9% Interest? 💰

📊 Can Your Property Support a $1 Million Commercial Real Estate Loan? The NOI & DSCR Math 🏦

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The $1 Million CRE Loan Test: How Much NOI Does the Property Really Need?

A commercial property can be profitable and still fail a lender’s underwriting test.

One of the most important reasons is Debt Service Coverage Ratio (DSCR). As interest rates rise, the annual payments required to support the same commercial real estate loan increase. That means the property needs more Net Operating Income (NOI) to qualify—even when the loan amount doesn’t change.

Consider a simple question:

If you want a $1 million commercial real estate loan, how much NOI does the property need at 7%, 8%, and 9% interest?

The answer demonstrates why commercial real estate investors and business owners should run the financing math before making an offer.

First: What Is DSCR?

DSCR measures a property's ability to cover its required debt payments:

DSCR = Net Operating Income ÷ Annual Debt Service

For example, if a property generates $125,000 of NOI and annual principal and interest payments are $100,000:

$125,000 ÷ $100,000 = 1.25x DSCR

A 1.25x DSCR means the property generates $1.25 of NOI for every $1.00 of annual debt service.

Commercial lenders commonly establish minimum DSCR requirements, although the actual requirement varies substantially by lender, property type, borrower, leverage and loan program.

The $1 Million CRE Loan Test

For illustration, assume:

·Loan amount: $1,000,000

·Amortization: 25 years

·Interest rates: 7%, 8% and 9%

·Minimum DSCR: 1.25x

·Stronger target DSCR: 1.35x

·Monthly principal-and-interest payments

Here is approximately what happens:

Interest Rate

Annual Debt Service

NOI @ 1.25x DSCR

NOI @ 1.35x DSCR

7%

$84,814

$106,017

$114,498

8%

$92,618

$115,772

$125,034

9%

$100,704

$125,879

$135,950

Figures are illustrative estimates and exclude lender fees, escrows and other transaction-specific costs.

What Happens When the Rate Goes From 7% to 9%?

This is where the underwriting lesson becomes important.

At a 1.25x DSCR, a $1 million loan at 7% requires approximately $106,017 in annual NOI.

At 9%, that same $1 million loan requires approximately $125,879 in NOI.

That's roughly $19,862 more annual NOI—an increase of nearly 19%—without borrowing another dollar.

The property didn't necessarily get worse.

The debt became more expensive.

Why Higher Rates Can Reduce Commercial Loan Proceeds

Investors often begin their analysis with loan-to-value:

"The property is worth $1.5 million, so I should be able to borrow $1 million."

But LTV is only part of the equation.

A lender may approve the property's value while still reducing the loan amount because its NOI cannot support the proposed debt service.

This is sometimes referred to as a DSCR constraint or debt-service constraint.

The maximum loan may effectively become the lower amount permitted by several underwriting tests, including:

Property Value → LTV Test

Property Cash Flow → DSCR Test

Borrower/Guarantor → Credit and Liquidity Test

Loan Program → Lender Guidelines

A property can therefore have sufficient collateral but insufficient cash flow to support the requested proceeds.

NOI Matters More Than Gross Revenue

Another frequent underwriting mistake is focusing on gross rents instead of NOI.

For an income-producing property, NOI generally starts with property revenue and subtracts applicable operating expenses before mortgage payments and certain other items.

Depending on the property and lender's underwriting methodology, expenses could include:

·Property taxes

·Insurance

·Repairs and maintenance

·Property management

·Utilities paid by the owner

·Replacement reserves or lender adjustments

·Vacancy and credit-loss assumptions

·Other recurring property operating expenses

A property generating $200,000 in gross income is not necessarily generating $200,000 available for debt service.

Lenders underwrite the cash flow remaining after operating expenses—not simply the rent collected.

A Powerful Way to Analyze a CRE Purchase

Before making an offer, work backward from the financing.

Suppose the investment generates approximately $110,000 of underwritten NOI.

At 7%, our example produces a DSCR of approximately:

$110,000 ÷ $84,814 = 1.30x

That could potentially satisfy a 1.25x requirement.

At 9%:

$110,000 ÷ $100,704 = 1.09x

Now the same property, with the same NOI and same requested $1 million loan, falls well below a 1.25x requirement.

The lender may need to reduce the loan amount, require additional equity, restructure the amortization, obtain a lower interest rate, or potentially decline the transaction.

Don't Ask Only, "What's the Rate?"

Commercial borrowers naturally focus on interest rates. But the better question is:

How does the rate affect my maximum loan proceeds and required NOI?

Loan structure can matter as much as headline pricing.

Changing amortization from 20 to 25 or 30 years, for example, can reduce scheduled debt service. Interest-only periods may affect near-term coverage. Different lenders may also have different DSCR standards and underwriting adjustments.

That is why commercial financing should be evaluated as a complete capital structure rather than as an interest-rate quote alone.

Run the DSCR Before You Make the Offer

For investors evaluating commercial real estate, a preliminary financing analysis can help answer several important questions:

How much NOI will the lender recognize?

How much debt can that NOI support?

What happens if rates increase before closing?

How much equity could be required?

Does the investment still produce acceptable returns after realistic financing assumptions?

Running these numbers early can identify a financing gap before it becomes a problem during due diligence.

The Bottom Line

For a hypothetical $1 million, 25-year amortizing commercial real estate loan, increasing the interest rate from 7% to 9% increases annual debt service from approximately $84,814 to $100,704.

At a 1.25x DSCR, required NOI increases from approximately $106,017 to $125,879.

That difference can determine whether a lender approves $1 million, reduces the proceeds, requires additional equity, or decides the transaction does not meet its underwriting standards.

The lesson: Don't just underwrite the property. Underwrite the debt.

For commercial real estate investors and business owners, understanding NOI, DSCR and loan structure before making an offer can lead to better-informed acquisition and financing decisions.

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Bill Rapp, CCIM
Director | CommLoan

📞 281-222-0433
📧 [email protected]
🌐 https://billrapp.commloan.com/

🌐 https://HoustonCommercialMortgage.com/

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