Commercial Real Estate Lending Explained: How CRE Loans Are Sized, Structured, and Serviced
By Zolvo · 6 min read
Commercial real estate lending is where the biggest tickets in commercial finance live. A single loan can run into the tens or hundreds of millions, secured by an income-producing property whose value depends on the rent it generates and the rate at which that income is capitalized. That combination, a large balance secured by an asset whose value moves with interest rates and occupancy, is what makes CRE underwriting distinct. This guide covers how CRE loans are sized against three separate constraints, the main loan structures, and why the servicing burden runs for the entire life of the loan.
What makes CRE lending different
Most commercial loans are underwritten primarily on the borrower's cash flow or on liquid collateral like receivables. A CRE loan is underwritten on the property. The building's net operating income, its occupancy, the quality of its tenants and their lease terms, and the market's capitalization rate all feed directly into how much a lender will advance. The borrower's own credit matters, but the deal stands or falls on whether the property can service the debt on its own.
This is why CRE lenders think in terms of the property first. A change in market cap rates can move an asset's value by millions without anything happening to the building itself, and a single large tenant not renewing can turn a comfortable loan into a stressed one. The underwriting has to survive those swings.
The three constraints that size a CRE loan
A CRE lender does not size a loan against one number. It runs three independent tests and lends to the most conservative of the three. The loan amount is the lowest figure the three constraints allow.
- Loan-to-value. The loan-to-value ratio caps the loan as a percentage of the property's appraised value, leaving an equity cushion that protects the lender if values fall.
- Debt service coverage. The debt service coverage ratio tests whether the property's net operating income comfortably covers the annual debt payment, usually requiring income well above the payment so there is room for vacancy or expense shocks.
- Debt yield. The debt yield measures net operating income against the loan amount, giving the lender a return-based view that is independent of the interest rate or amortization, which is why it has become a favored constraint since the last downturn.
Debt yield matters because LTV and DSCR can both be flattered by cheap debt and generous appraisals; debt yield cannot. To see how the binding constraint shifts as you change value, income, and rate assumptions, our CRE loan sizing calculator runs all three tests at once, and the DSCR calculator isolates the coverage test.
The main CRE loan structures
CRE debt is not one product. The structure follows the business plan for the property.
- Permanent (stabilized) loans finance a fully leased, income-producing property. They carry longer terms, often with amortization over 25 to 30 years, and price for stability.
- Bridge loans finance a property in transition, one being repositioned, re-leased, or renovated, where the income does not yet support permanent debt. They are shorter, floating-rate, and priced for the added risk. The distinction between a bridge loan and a conventional loan comes down to whether the asset is stabilized today or expected to be.
- Construction loans fund ground-up development or major renovation, advancing in draws against completed work. Because a project under construction produces no income, these loans usually carry an interest reserve, a pool of loan proceeds set aside to make the interest payments until the property can carry itself.
Recourse, guarantees, and how the risk is shared
Large CRE loans are often non-recourse, meaning the lender's remedy in a default is the property itself rather than the borrower's other assets. That is not absolute: most non-recourse loans include carve-outs, backed by a guarantee, that spring into full recourse if the borrower commits fraud, files a bad-faith bankruptcy, or otherwise violates the deal. Smaller CRE loans are more often full recourse. Where a deal sits on that spectrum is one of the most heavily negotiated points, because it determines who absorbs the loss if the property cannot repay.
The servicing runs for the life of the loan
A CRE loan closes once and is serviced for years. Over that life the lender has to keep watch on the very inputs that sized the loan in the first place: rent rolls and occupancy, the property's operating statements, real estate tax and insurance escrows, and covenant tests like a minimum DSCR that must hold at each measurement date. A construction loan adds draw administration and inspections; a bridge loan adds monitoring of the business plan against milestones.
When those inputs drift, the lender needs to know early. A DSCR that slips below its covenant, a major tenant that gives notice, or a construction project that falls behind are all signals that a performing loan is heading toward trouble, and catching them early is the difference between a modest workout and a large loss. For how a stressed loan is handled once those signals appear, see our guide on the distressed commercial loan lifecycle, and for the servicing discipline that keeps every one of these inputs current across a portfolio, loan workout is only the last resort after monitoring has done its job. The broader treatment of what lenders track over a loan's life is in our guide to the key metrics lenders underwrite and monitor.
Frequently asked questions
How is a commercial real estate loan sized?
A CRE lender runs three independent tests and lends to the most conservative result: loan-to-value caps the loan as a share of appraised value, debt service coverage tests whether the property's income covers the payment, and debt yield measures income against the loan amount independent of rate. The final loan amount is the lowest figure the three constraints allow.
What is debt yield and why do lenders use it?
Debt yield is net operating income divided by the loan amount, expressed as a percentage. Unlike loan-to-value and debt service coverage, it is not affected by the interest rate, amortization schedule, or appraised value, so it cannot be flattered by cheap debt or an aggressive appraisal. That independence is why it became a favored sizing constraint after the last real estate downturn.
What is the difference between a bridge loan and a permanent CRE loan?
A permanent loan finances a stabilized, fully leased property and carries a longer term at a lower rate. A bridge loan finances a property in transition, being repositioned, re-leased, or renovated, whose income does not yet support permanent debt. Bridge loans are shorter, usually floating rate, and priced for the added risk until the property stabilizes and can be refinanced.
Are commercial real estate loans recourse or non-recourse?
Large CRE loans are often non-recourse, so the lender's remedy in a default is the property rather than the borrower's other assets. Most non-recourse loans still include carve-outs backed by a guarantee that trigger full recourse for fraud, bad-faith bankruptcy, or similar bad acts. Smaller CRE loans are more frequently full recourse. The exact terms are heavily negotiated because they determine who bears the loss.