Plain-English definitions of commercial real estate debt, equity, underwriting, and development terms, written by the capital markets team at FOCAL.
Debt & Financing
Bridge Loan
A bridge loan is short-term commercial real estate financing, typically 12 to 36 months, used to acquire or reposition a property before it qualifies for permanent debt. Bridge loans price at a spread over a floating index such as SOFR, are usually interest-only, and are sized against the as-stabilized value or a debt yield test rather than current income.
Construction Loan
A construction loan funds the ground-up development or heavy renovation of a property, advanced in draws against completed work rather than as a single upfront amount. Construction loans are typically floating-rate, interest-only, sized to a loan-to-cost limit, and repaid by a refinance into permanent debt or a sale at completion.
Permanent Loan
A permanent loan is long-term mortgage financing, generally 5 to 30 years, placed on a stabilized income-producing property. Permanent loans are usually fixed-rate and amortizing, and are underwritten to in-place cash flow using debt service coverage and loan-to-value tests.
Agency Debt (Fannie Mae / Freddie Mac)
Agency debt is multifamily mortgage financing originated under Fannie Mae or Freddie Mac programs and sold with a government-sponsored guarantee. Agency loans offer some of the lowest fixed rates and longest terms available for stabilized apartment properties, generally non-recourse with 30-year amortization.
CMBS (Commercial Mortgage-Backed Securities)
CMBS is a form of commercial mortgage financing in which loans are pooled, securitized, and sold to bond investors. CMBS loans are non-recourse with fixed rates and 5 or 10 year terms, but they trade flexibility for proceeds: servicing is rigid and prepayment usually requires defeasance or yield maintenance.
SOFR (Secured Overnight Financing Rate)
SOFR is the benchmark floating interest rate index that replaced LIBOR in US lending markets in 2022. Floating-rate commercial real estate loans are quoted as a spread over term SOFR, so a loan priced at SOFR plus 300 basis points pays the current SOFR rate plus 3.00%.
Interest Rate Cap
An interest rate cap is a hedge purchased alongside a floating-rate loan that reimburses the borrower whenever the index rises above an agreed strike rate. Lenders on bridge and construction loans commonly require a rate cap at closing, and the upfront premium scales with the strike, the notional amount, and the term.
Interest Rate Swap
An interest rate swap is a hedge that converts a floating-rate loan into a synthetic fixed rate by exchanging floating payments for fixed payments with a counterparty. Unlike a cap, a swap has no upfront premium but creates two-way exposure: breaking it early can produce either a gain or a significant breakage cost.
DSCR (Debt Service Coverage Ratio)
DSCR is net operating income divided by annual debt service, and it measures how comfortably a property’s cash flow covers its loan payments. A DSCR of 1.25x means the property earns 25% more than its debt service; most permanent lenders require a minimum between 1.20x and 1.35x.
Debt Yield
Debt yield is net operating income divided by the loan amount, expressed as a percentage. Lenders use it as a size test that ignores interest rates and amortization: a 10% debt yield means the property’s income equals 10% of the loan, and bridge and CMBS lenders commonly set minimums between 8% and 10%.
LTV (Loan-to-Value)
Loan-to-value is the loan amount divided by the appraised value of the property, expressed as a percentage. LTV is the primary leverage test on stabilized assets: a $7 million loan on a $10 million property is 70% LTV, near the ceiling for most senior commercial mortgages.
LTC (Loan-to-Cost)
Loan-to-cost is the loan amount divided by the total project cost, including land, hard costs, soft costs, and financing costs. LTC is the leverage test used on construction and value-add deals where cost, not current value, is the relevant denominator; construction lenders typically cap senior debt between 55% and 70% LTC.
Recourse vs. Non-Recourse
A recourse loan lets the lender pursue the guarantor’s personal assets if the property cannot repay the debt, while a non-recourse loan limits the lender’s remedy to the property itself. Most bank construction lending carries some recourse, while agency, CMBS, life company, and many debt fund loans are non-recourse subject to standard carve-outs.
Bad-Boy Carve-Outs
Bad-boy carve-outs are exceptions in a non-recourse loan that make the guarantor personally liable if specified misconduct occurs, such as fraud, misappropriation of funds, unauthorized transfers, or a voluntary bankruptcy filing. They convert a non-recourse loan into a recourse loan only when the sponsor breaks the listed rules.
Interest-Only (IO) Period
An interest-only period is a stretch of a loan term during which the borrower pays only interest and no principal, maximizing cash flow. Bridge and construction loans are typically full-term interest-only, while permanent lenders may offer 1 to 10 years of IO before amortization begins, depending on leverage.
Amortization
Amortization is the scheduled repayment of loan principal over time through the periodic payment. Commercial mortgages commonly amortize on a 25 or 30 year schedule even when the term is shorter, which creates a balloon balance due at maturity.
Prepayment Penalty
A prepayment penalty is the fee a borrower pays to retire a loan before maturity. Common structures include step-down schedules (for example 3-2-1% of the balance by year), yield maintenance, and defeasance; the structure materially affects exit and refinance flexibility and should be negotiated at the term sheet stage.
Yield Maintenance
Yield maintenance is a prepayment formula that compensates a fixed-rate lender for the interest it would have earned had the loan run to maturity, calculated by discounting the remaining payments at current Treasury yields. When rates have fallen since closing, yield maintenance penalties can be substantial.
Defeasance
Defeasance is the prepayment mechanism used in CMBS loans, in which the borrower substitutes a portfolio of government securities that replicates the loan’s remaining payments instead of paying the loan off with cash. Defeasance requires specialist consultants and several weeks of lead time, so it must be planned into any sale or refinance timeline.
Extension Option
An extension option is a contractual right to lengthen a loan’s term, typically in 6 or 12 month increments, subject to conditions called extension tests. Bridge loans are commonly structured as an initial term plus one or two extensions conditioned on debt yield or DSCR thresholds, an updated rate cap, and an extension fee.
Spread
Spread is the margin a lender charges over its benchmark index, quoted in basis points. A bridge loan at SOFR plus 350 has a 350 basis point spread; spread reflects the lender’s read of deal risk, sponsor strength, leverage, and market liquidity.
Basis Point (bps)
A basis point is one one-hundredth of a percentage point, so 100 basis points equal 1.00%. Interest rate spreads, fee quotes, and rate movements in commercial real estate finance are conventionally quoted in basis points.
Loan Constant
The loan constant is annual debt service divided by the loan amount, expressed as a percentage. It captures the combined effect of rate and amortization on cash flow, and a property whose cap rate exceeds the loan constant generates positive leverage.
Lockbox / Cash Management
A lockbox is a lender-controlled account into which property income is deposited, used to enforce payment priority on larger commercial loans. A springing lockbox activates only after a trigger event such as a DSCR breach, while a hard lockbox routes all revenue through the lender’s account from day one.
Mezzanine Debt
Mezzanine debt is financing secured by a pledge of the ownership interests in the borrower rather than by a mortgage on the property, sitting between senior debt and equity in the capital stack. If the mezzanine loan defaults, the lender’s remedy is a UCC foreclosure on the equity pledge, which lets it take control of the property-owning entity, subject to an intercreditor agreement with the senior lender.
Refinance
A refinance replaces an existing loan with a new one, either to lower the rate, extend the term, or convert construction or bridge debt into permanent financing. A cash-out refinance sizes the new loan above the old balance and returns the difference to the owner, a common way to recover invested equity without selling.
Take-Out Financing
Take-out financing is the permanent loan that repays a construction or bridge loan once a project is built and stabilized. Construction lenders underwrite the plausibility of the take-out from day one, testing whether projected income supports the permanent debt needed to retire their balance.
Rate Lock
A rate lock fixes the interest rate on a loan between application and closing, protecting the borrower from market movement during that window. Agency and life company lenders offer early rate lock programs, sometimes for a deposit, which can be decisive in a rising-rate environment.
Equity & Capital Structure
Capital Stack
The capital stack is the full set of financing layers funding a real estate deal, ordered by repayment priority: senior debt first, then mezzanine debt or preferred equity, then common equity. Positions lower in the stack take losses first and demand higher returns in exchange.
LP Equity (Limited Partner Equity)
LP equity is the passive investment capital in a real estate partnership, typically supplying 80% to 95% of the total equity while the sponsor contributes the remainder. Limited partners have no operational control and receive a preferred position in distributions ahead of the sponsor’s promote.
GP Equity (General Partner Equity)
GP equity is the capital the sponsor, or general partner, invests in its own deal, commonly 5% to 20% of total equity. The GP co-invest aligns the sponsor with investors, and its size is one of the first questions institutional LPs and lenders ask.
Co-GP Capital
Co-GP capital is an investment into the general partner position itself, sharing in the sponsor’s promote and fees rather than investing as a limited partner. Sponsors raise co-GP capital when their own balance sheet cannot fund the required GP co-investment, trading a share of the upside for the ability to control larger deals.
Preferred Equity
Preferred equity is an investment that sits between debt and common equity, receiving a fixed priority return before common equity distributions but ranking behind all lenders. Unlike mezzanine debt, preferred equity is a partnership interest rather than a loan, so its remedies come from the operating agreement, often the right to take control of the partnership after a default.
Common Equity
Common equity is the last-priority capital in a real estate deal, absorbing losses first and collecting the residual upside after debt service and preferred returns. It carries the highest risk and the highest potential return of any position in the capital stack.
The promote is the sponsor’s disproportionate share of profits above agreed return hurdles, the core incentive compensation in real estate partnerships. A typical structure might give the sponsor 20% to 30% of profits after investors receive their preferred return, stepping up at higher IRR hurdles.
Distribution Waterfall
A distribution waterfall is the contractual order in which deal cash flows are split between investors and the sponsor. A common structure returns capital first, then pays a preferred return, then splits remaining profits at promoted percentages that escalate as IRR hurdles are cleared.
Preferred Return (Pref)
A preferred return is the minimum annual return, commonly 6% to 10%, that investors must receive on their capital before the sponsor participates in profits. The pref accrues on invested capital and, depending on the agreement, may compound and must be caught up before any promote is paid.
IRR (Internal Rate of Return)
IRR is the annualized discount rate that sets the net present value of a deal’s cash flows to zero, and it is the standard measure of time-weighted return in real estate investing. Because IRR rewards getting capital back quickly, it is always read alongside equity multiple, which measures total profit regardless of timing.
Equity Multiple
Equity multiple is total cash distributed to investors divided by total cash invested. A 2.0x multiple means investors doubled their money; unlike IRR it ignores how long the capital was outstanding, which is why the two metrics are quoted together.
Pari Passu
Pari passu means two or more parties share distributions on equal footing and in proportion to their investment, with neither having priority. In waterfall terms, capital contributed pari passu is returned pro rata at the same tier rather than sequentially.
Joint Venture (JV)
A real estate joint venture is a partnership between a sponsor who operates the deal and a capital partner who funds most of the equity. The JV agreement governs control, major decisions, fees, the waterfall, and exit rights such as buy-sell and forced-sale provisions.
Syndication
A real estate syndication pools capital from multiple passive investors into a single entity that acquires a property, organized and managed by a sponsor. Syndications are securities offerings, typically conducted under SEC Regulation D exemptions with accredited investors.
The sponsor is the party that finds, structures, capitalizes, and operates a real estate deal, also called the general partner or operator. Lenders and investors underwrite the sponsor’s track record, balance sheet, and liquidity as heavily as the property itself.
Key Principal / Guarantor
A key principal is the individual behind a sponsor entity whom the lender looks to for the loan’s guarantees, whether full recourse or non-recourse carve-outs. Lenders test key principals for net worth, typically equal to the loan amount, and post-closing liquidity, commonly 10% of the loan.
Underwriting & Metrics
NOI (Net Operating Income)
Net operating income is a property’s revenue minus operating expenses, before debt service, capital expenditures, and income taxes. NOI is the foundational cash flow number in commercial real estate: values, loan sizes, and coverage ratios are all computed from it.
Cap Rate (Capitalization Rate)
A cap rate is net operating income divided by property value, expressed as a percentage, and it is the market’s shorthand for pricing income streams. A property earning $500,000 of NOI valued at a 5% cap rate is worth $10 million; lower cap rates mean higher prices per dollar of income.
Exit Cap Rate
The exit cap rate is the capitalization rate an underwriter assumes a property will sell at when the business plan ends. Because small changes move terminal value dramatically, disciplined underwriting typically assumes an exit cap equal to or higher than today’s cap rate to build in conservatism.
A pro forma is the financial model projecting a property’s revenue, expenses, financing, and returns over the hold period. Reading a pro forma critically means testing its rent growth, vacancy, expense inflation, exit cap, and refinance assumptions rather than accepting the headline IRR.
Stabilization
Stabilization is the point at which a property reaches its expected steady-state occupancy and income, conventionally around 90% occupancy sustained for 90 days. Stabilization is the trigger for construction loan take-outs, earn-outs, and the shift from cost-based to income-based valuation.
Lease-Up
Lease-up is the period between a project’s completion and stabilization, during which units or suites are marketed and occupied for the first time. Lease-up pace, measured in units absorbed per month, drives interest carry, and lenders track it weekly because it determines whether the deal hits its covenant tests on schedule.
Yield on Cost
Yield on cost is stabilized net operating income divided by total project cost, the development equivalent of a cap rate. Comparing yield on cost to market cap rates measures the development spread: building to a 6.5% yield on cost in a 5% cap rate market creates roughly 150 basis points of value margin.
Development Spread
The development spread is the difference between a project’s yield on cost and the market cap rate for the finished asset, representing the profit margin for taking development risk. Institutional developers typically require 100 to 200 basis points of spread before proceeding.
Financial Covenants
Financial covenants are ongoing tests in a loan agreement, most commonly minimum DSCR, minimum debt yield, or maximum LTV, that the property must satisfy after closing. Breaching a covenant is not automatically a default but typically triggers remedies such as a cash sweep, a paydown requirement, or loss of extension rights.
T-12 (Trailing Twelve Months)
A T-12 is a property’s actual income and expense statement over the most recent twelve months, the standard document lenders use to underwrite in-place cash flow. Underwriters compare the T-12 and the current rent roll against the seller’s pro forma to separate real income from projections.
Rent Roll
A rent roll is the tenant-by-tenant schedule of a property’s leases, showing units, tenants, rents, lease dates, and concessions. It is the primary evidence of in-place income and the starting point for any acquisition or financing underwrite.
As-Is vs. As-Stabilized Value
As-is value is what a property is worth today in its current condition and occupancy, while as-stabilized value is its projected worth once the business plan is complete. Bridge and construction lenders size loans against both: proceeds at closing test against as-is or cost, and the exit tests against as-stabilized value.
Break-Even Occupancy
Break-even occupancy is the occupancy level at which a property’s income exactly covers operating expenses plus debt service. A deal with 75% break-even occupancy can lose a quarter of its tenants before cash flow goes negative, making the metric a quick stress test of downside resilience.
Sensitivity Analysis
A sensitivity analysis re-runs a pro forma across ranges of key assumptions, most commonly exit cap rate, rents, and interest rates, to show how returns respond. A deal whose IRR survives a 50 to 100 basis point cap rate expansion and a rent miss is more resilient than one that only works in the base case.
Basis
Basis is an investor’s total cost in a property, including purchase price, closing costs, and capital invested, usually quoted per unit or per square foot. Buying below replacement cost or below comparable trades is described as a low basis, the most durable protection in a downturn.
Replacement Cost
Replacement cost is what it would cost to build a comparable property new at today’s land, labor, and material prices. Acquiring below replacement cost insulates an owner from new supply, because a developer cannot build a competing project without charging higher rents.
Development & Entitlements
Entitlements
Entitlements are the government approvals that establish the legal right to develop a property for a specific use, density, and design. The entitlement process spans zoning review, environmental clearance, and public hearings, and completing it typically increases land value substantially before any construction begins.
Zoning
Zoning is the local regulatory framework dividing a jurisdiction into districts that control what can be built where, including allowed uses, density, height, and setbacks. A parcel’s zoning is the starting point of every development feasibility analysis.
By-Right (Ministerial) Development
A by-right project complies fully with existing zoning and therefore requires only ministerial approvals, with no discretionary hearings or subjective review. By-right paths are faster and far more certain than discretionary approvals, and several California housing laws now convert qualifying projects to ministerial review.
Discretionary Approval
A discretionary approval is a land use decision a public agency may grant or deny based on judgment, such as a conditional use permit, variance, or zone change. Discretionary approvals generally trigger environmental review and public hearings, adding time, cost, and political risk to a project.
CEQA (California Environmental Quality Act)
CEQA is the California statute requiring public agencies to analyze and disclose the environmental impacts of discretionary projects before approving them. CEQA review ranges from exemptions to full environmental impact reports, and it is a primary driver of entitlement timelines and litigation risk in California development.
Density Bonus
A density bonus is a state-mandated entitlement that lets a residential project exceed base zoning density in exchange for including affordable units. California’s Density Bonus Law grants up to 50% or more additional density plus concessions such as reduced parking and height increases, scaled to the affordability level provided.
FAR (Floor Area Ratio)
Floor area ratio is a project’s total building floor area divided by its lot area, the primary zoning control on building size. A 2.0 FAR on a 10,000 square foot lot permits 20,000 square feet of building, before any bonuses or exemptions.
Conditional Use Permit (CUP)
A conditional use permit is a discretionary approval allowing a use that zoning permits only with case-by-case review, subject to conditions the agency attaches. CUPs run with the land in most jurisdictions but can carry operational conditions that materially affect value.
Variance
A variance is permission to deviate from a specific zoning development standard, such as a setback or height limit, granted when strict application would cause unique hardship. Variances are discretionary, fact-specific, and harder to obtain than administrative adjustments.
Impact Fees
Impact fees are one-time charges local governments levy on new development to fund infrastructure and services such as schools, parks, and transportation. Fees vary widely by jurisdiction and are a line item developers must underwrite early, as they can run from a few thousand to tens of thousands of dollars per unit.
Prevailing Wage
Prevailing wage is a government-set minimum compensation schedule for construction labor that applies to public works and, increasingly, to private projects using certain streamlining laws or subsidies. Prevailing wage requirements typically raise hard costs materially, so confirming applicability is a threshold feasibility question.
Certificate of Occupancy (CO / TCO)
A certificate of occupancy is the government sign-off that a completed building complies with code and may be legally occupied. A temporary certificate of occupancy, or TCO, allows phased occupancy before final completion and is often the milestone that starts lease-up and triggers loan conversion tests.
Hard Costs
Hard costs are the direct construction costs of a project: labor, materials, site work, and the general contractor’s charges. Hard costs typically represent 60% to 75% of a development budget and are the component most exposed to escalation and change orders.
Soft Costs
Soft costs are the non-construction costs of a development, including architecture and engineering, permits and fees, legal, insurance, taxes during construction, marketing, and financing costs. Soft costs commonly run 20% to 30% of budget and continue accruing even when construction pauses.
Contingency
A contingency is the budget reserve, commonly 5% to 10% of hard costs, held against unforeseen construction costs and change orders. Lenders require contingency in every construction budget, control its release through the draw process, and treat its depletion rate as an early warning indicator.
Opportunity Zone
An opportunity zone is a designated census tract in which investors can defer and partially eliminate capital gains taxes by investing realized gains through a qualified opportunity fund. The core benefit is that appreciation on an opportunity zone investment held at least 10 years is federally tax-free.
Deal Execution & Structure
Term Sheet
A term sheet is the pre-contract summary of a loan’s or investment’s key business terms: proceeds, rate, term, fees, guarantees, covenants, and conditions. Most term sheets are non-binding except for exclusivity and deposit provisions, and negotiating them carefully is far cheaper than negotiating loan documents later.
LOI (Letter of Intent)
A letter of intent is the preliminary agreement outlining the principal terms of a purchase, lease, or joint venture before full contracts are drafted. LOIs are typically non-binding on the deal itself while binding on process points such as confidentiality and exclusivity.
Due Diligence
Due diligence is the buyer’s or lender’s investigation of a property before closing, covering title, survey, environmental reports, physical condition, leases, financials, and zoning compliance. Purchase contracts typically provide a due diligence period during which the buyer can terminate and recover its deposit.
Phase I Environmental Site Assessment
A Phase I environmental site assessment is the standard investigation of a property’s environmental history and condition, based on records review and site inspection without physical sampling. Lenders require a Phase I on essentially every commercial mortgage; findings of concern escalate to a Phase II with soil and groundwater testing.
Title Insurance
Title insurance protects an owner or lender against defects in a property’s ownership history, such as liens, easements, or competing claims, discovered after closing. Lenders universally require a lender’s policy in the loan amount, and owners typically purchase an owner’s policy at acquisition.
ALTA Survey
An ALTA survey is a detailed land survey prepared to national standards jointly set by the American Land Title Association and NSPS, showing boundaries, improvements, easements, and encroachments. It is the survey standard lenders and title companies require for commercial closings.
Estoppel Certificate
An estoppel certificate is a tenant’s signed confirmation of its lease terms, rent, and any landlord defaults, relied on by buyers and lenders at closing. Estoppels prevent tenants from later contradicting the facts certified, which is why commercial leases obligate tenants to deliver them.
SNDA (Subordination, Non-Disturbance and Attornment)
An SNDA is a three-way agreement among lender, landlord, and tenant in which the tenant subordinates its lease to the mortgage, the lender agrees not to disturb the tenant’s occupancy after foreclosure, and the tenant agrees to recognize the lender as landlord. Anchor and credit tenants routinely require non-disturbance protection.
Intercreditor Agreement
An intercreditor agreement is the contract between a senior lender and a junior lender, such as a mezzanine lender, allocating rights on payment priority, cure, and enforcement. It governs what the junior lender may do after a default, including its right to cure the senior loan and take over the borrower.
Guaranty
A guaranty is a key principal’s promise to answer for loan obligations, ranging from full repayment guarantees to targeted forms: completion guarantees on construction loans, carry guarantees covering interest and operating shortfalls, and carve-out guarantees behind non-recourse debt.
Draw Schedule / Draw Process
The draw process is how construction loan proceeds are disbursed: the borrower submits monthly requests documenting completed work, the lender’s inspector verifies progress, and funds are released against the approved budget. Retainage, commonly 5% to 10%, is withheld from each draw until completion milestones are met.
Holdback / Earn-Out
A holdback is a portion of loan proceeds reserved at closing and released only when the property hits agreed performance tests, such as reaching a target debt yield. Bridge lenders use holdbacks and earn-outs to fund future capital expenditures or reward stabilization without re-underwriting the loan.
GMP Contract (Guaranteed Maximum Price)
A GMP contract is a construction agreement in which the general contractor commits to deliver the work at or below a stated maximum price, absorbing overruns above it except for owner-driven changes. Construction lenders strongly prefer GMP contracts because they cap the cost side of the loan’s risk.
General Contractor (GC)
The general contractor is the firm responsible for executing a project’s construction, holding the subcontracts and delivering the building per plans, budget, and schedule. GC selection, bonding capacity, and the contract structure (GMP versus cost-plus) are central execution risks lenders underwrite.
Owner’s Representative
An owner’s representative is a professional who manages a construction project on the owner’s behalf, overseeing the architect, contractor, budget, schedule, and draw process. Owners without in-house development staff hire an owner’s rep to protect their interests against cost and schedule drift.
Escrow
Escrow is the neutral third-party process that holds funds and documents during a real estate transaction and releases them when all closing conditions are satisfied. In lending, escrows or impounds also refer to reserves the lender collects monthly for taxes, insurance, and replacements.
1031 Exchange
A 1031 exchange lets an investor defer capital gains tax by reinvesting sale proceeds from one investment property into another of equal or greater value. The rules are strict: replacement property must be identified within 45 days of sale and acquired within 180 days, with proceeds held by a qualified intermediary throughout.