D

eveloping the net operating income (NOI) or cash flow is an important first step in the prudent underwriting of a commercial real estate (CRE) property.

Quantitative analysis is one facet of prudent real estate underwriting, but the real estate math isn't a black‐and‐white exercise, nor is it simple formula lending. Many qualitative judgments feed into your estimates of property cash flow, coverage, and value that come from quantitative analysis. Your analysis should be completed in the context of the qualitative credit risk assessment. Doing so will avoid over‐advancing on potentially weak property cash flow streams that will in turn jeopardize repayment prospects and bank portfolio quality.

An example of the interplay between qualitative and quantitative judgments is the vacancy factor applied to lease income for a project and how it will affect cash flow. This quantitative aspect cannot be interpreted without understanding the qualitative factors behind it. CRE operates in a dynamic marketplace that is affected by the surrounding properties, demographics, and local, regional, and national economics. Unlike other businesses, an income‐producing property can't simply move its operation to another market or shift its product offering and price point.

It is important to remember that the numbers resulting from the quantitative analysis are only estimates. It's impossible to be absolutely certain what a property's future economics will be, despite the substantial amount of thought and diligence that is put into the analysis. There are simply too many variables in the analysis outside management's control, such as market rents, vacancy, and investor appetites.

Lenders' assessments factor in their perception of the reliability of the calculated property cash flow. Consequently, the final underwriting must allow room for variable fluctuation. In workout or liquidation scenarios, an owner‐occupied property may need to be sold as an income‐producing property. If an owner‐occupied building or project is converted into leased space, it's important to consider whether there could be additional, non‐owner‐occupied uses for the site that would help ensure the  marketability of the collateral.It is important to remember that the numbers resulting from the quantitative analysis are only estimates.

It's impossible to be absolutely certain what a property's future economics will be, despite the substantial amount of thought and diligence that is put into the analysis. There are simply too many variables in the analysis outside management's control, such as market rents, vacancy, and investor appetites. Lenders' assessments factor in their perception of the reliability of the calculated property cash flow. Consequently, the final underwriting must allow room for variable fluctuation. In workout or liquidation scenarios, an owner‐occupied property may need to be sold as an income‐producing property. If an owner‐occupied building or project is converted into leased space, it's important to consider whether there could be additional, non‐owner‐occupied uses for the site that would help ensure the marketability of the collateral.