Commercial real estate underwriting glossary

Capitalization Rate (Cap Rate)

The capitalization rate (cap rate) is a property's annual net operating income (NOI) divided by its market value or purchase price, expressed as a percentage. It represents the unlevered, first-year return on an all-cash purchase and is the primary lever the market uses to price commercial real estate.

Net Operating Income (NOI)

Net Operating Income (NOI) is a property's annual income after operating expenses but before debt service, capital expenditures, income taxes, and depreciation. It measures the cash a property generates from operations regardless of how it is financed.

Debt Service Coverage Ratio (DSCR)

Debt Service Coverage Ratio (DSCR) measures how many times a property's net operating income (NOI) covers its annual debt service (principal + interest). It is the primary lender test for whether cash flow can service the loan: a DSCR of 1.25x means NOI is 25% larger than the mortgage payment.

Internal Rate of Return (IRR)

Internal Rate of Return (IRR) is the annualized discount rate at which the net present value (NPV) of all a deal's cash flows — the initial equity outlay, interim distributions, and the sale proceeds — equals zero. It is a time-weighted return that accounts for both the size and the timing of every cash flow.

Equity Multiple

Equity multiple is the ratio of total cash distributions received to total equity invested — how many times an investor gets their money back over the life of a deal. An equity multiple of 2.0x means every $1 invested returned $2 in total distributions (the original $1 plus $1 of profit).

Cash-on-Cash Return

Cash-on-cash return is the ratio of a property's annual pre-tax cash flow to the total equity invested, expressed as a percentage. It measures the current cash yield an investor earns on the actual dollars they put into a deal, after debt service but before appreciation, taxes, and any eventual sale.

Equity Waterfall

An equity waterfall is the contractual, tiered order in which a real estate deal's distributable cash is split between limited partners (LPs) and the general partner (GP). Cash flows down through sequential tiers — return of capital, a preferred return, a GP catch-up, then promote splits — with each tier fully satisfied before cash spills into the next.

GP Promote (Carried Interest)

The GP promote (also called carried interest) is the outsized share of a deal's profits that the general partner earns once limited partners have received their preferred return and, typically, their capital back. It is performance-based compensation disproportionate to the GP's small equity contribution — e.g., a 20% promote paid on capital that may represent only 5–10% of the equity.

Preferred Return (Pref)

A preferred return (or "pref") is a priority rate of return—typically 6% to 10% annually—that limited partners (LPs) earn on their invested capital before the general partner (GP) receives any share of profits. It sits at the first tier of the equity waterfall and compensates LPs for taking first-loss risk.

Pro Forma

A real estate pro forma is a projected, multi-year financial statement that forecasts a property's income, operating expenses, net operating income (NOI), debt service, and equity returns over the holding period. It is the analytical backbone of underwriting — a forward-looking model of how a deal is expected to perform, not a record of what has already occurred.

Yield on Cost (YoC)

Yield on Cost (YoC) is a return-on-cost metric equal to a property's stabilized net operating income (NOI) divided by its total project cost — the all-in acquisition or development basis plus capital improvements. It answers "what unleveraged yield will this deal produce once it's fully built out and leased up?"

Debt Yield

Debt yield is a lender's risk metric equal to a property's net operating income divided by the total loan amount, expressed as a percentage. It measures how quickly a lender would recover its loan from the property's cash flow, independent of interest rate, amortization, or purchase price.