Learn What Affects Commercial Mortgage Rates And How Lenders Evaluate Deals

You find a great commercial property—a 12-unit apartment building, a small warehouse. You run the numbers, and they work... at a 6% interest rate. But when you talk to a lender, they quote you 7.5%. That 1.5% difference can turn a cash-flowing asset into a money pit. Why the gap?

Commercial mortgage rates aren't set by a distant federal board and handed down. They are negotiated, risk-adjusted prices that a lender charges you, for this specific deal, on this specific day. To get the best rate, you need to think like the lender.

Let's break down what's really going on behind the curtain.

Part 1: What Affects Your Commercial Mortgage Rate (The Five Levers)

The rate is a function of the lender's cost of funds plus a premium for risk. Here are the levers you control (somewhat) and the ones you don't.

1. The "Benchmark" Rate (What You Can't Control)

This is the foundation. Commercial loans are typically priced as a spread over a benchmark index.

• Common Benchmarks: SOFR (Secured Overnight Financing Rate) has largely replaced LIBOR. For smaller loans, the Prime Rate or a U.S. Treasury Yield (e.g., 5-year Treasury) might be used.
• What it means: When the news says "The Fed raised rates," it's pushing these benchmarks up. Your rate will be "SOFR + 2.50%" or "Prime + 1%." You have zero control over SOFR or Prime. Your fight is over the "spread" (the +2.50%).

2. The Property's "Story" (The Most Important Lever)

The property itself is the primary collateral. Lenders underwrite the asset first.

• Property Type & Quality (Asset Class): A brand-new, fully-leased Class A medical office in a major city is "low risk." A vacant, single-tenant retail box on a declining corridor is "high risk." Low risk = lower spread. High risk = higher spread (or a "no").
• Lease Strength (Credit Tenancy): A property with a 10-year, triple-net lease to a national pharmacy (Walgreens, CVS) is essentially financing a corporate bond secured by real estate. That gets the best rates. A property with mom-and-pop tenants on 2-year leases is riskier—higher spread.
• Location, Location, Location: Not just city, but submarket. A warehouse in a thriving logistics hub vs. one in a decaying industrial zone. The lender's appraiser will have a huge say here.

3. The Borrower's "Strength" (Your Financial Resume)

You are being underwritten too. If the property stumbles, can you cover the shortfall?

• Net Worth & Liquidity: Lenders want to see that your total net worth exceeds the loan amount and that you have significant liquid assets (cash, stocks) outside of the deal. This is your "skin in the game" beyond the down payment. More liquidity = lower perceived risk.
• Experience: A first-time investor buying a 20-unit complex is a red flag. A sponsor with a proven track record of managing similar assets gets a better rate. If you're new, having an experienced partner or property manager locked in can help.
• Credit Score: While less dominant than in residential, a strong personal (and business) credit score (720+) is expected for the best terms. It speaks to your financial responsibility.

4. The Loan's Specifics (Structure = Risk)

The terms of the loan itself change the risk profile.

• Loan-to-Value Ratio (LTV): This is huge. A 60% LVR loan (you put 40% down) is far less risky for the lender than an 80% LVR loan. Lower LVR = Lower Spread. Putting more money down is the clearest way to buy a better rate.
• Debt Service Coverage Ratio (DSCR): This measures the property's income against the loan payment. DSCR = Net Operating Income (NOI) / Annual Debt Service. Most lenders require a minimum 1.20x - 1.25x. A stronger DSCR (e.g., 1.40x) shows a comfortable cushion and can secure a better rate.
• Loan Term & Amortization: A 5-year interest-only loan is riskier for the lender than a 10-year loan amortizing over 25 years. Shorter terms and interest-only periods often come with a slightly higher spread due to refinance risk.

5. The Lender's Appetite & Costs

• Lender Type: Different lenders have different mandates. A life insurance company seeks long-term, low-risk, low-yield loans. A CMBS (Conduit) lender pools loans for sale to investors and has very standardized, box-checking criteria. A local/regional bank may be more flexible but have a higher cost of funds. Their goals affect the rate.
• Competition & Relationship: If you're a valued customer with a strong history at a local bank, you have negotiating power. Shopping the deal to multiple lenders creates competition, which can shave basis points (0.25%) off your spread.

Part 2: How Lenders Evaluate Deals (The Underwriting Process)

They're not just guessing. They follow a rigorous checklist to answer one question: "What is the probability we get all our money back, with interest, on schedule?"

Phase 1: The Property Underwriting (The "Asset" Test)

1. Appraisal: They will order a formal appraisal. The appraiser determines value based on income capitalization (most important), sales comparables, and replacement cost. The loan is based on the lower of purchase price or appraised value.
2. Phase I Environmental Report: For most non-office/retail properties, they'll require an environmental assessment to check for soil/groundwater contamination (a massive liability).
3. Property Condition Assessment (PCA): An engineer's report on the roof, HVAC, structure, and deferred maintenance. They want to know if a major repair will undermine the property's income.
4. Lease & Rent Roll Analysis: They will dissect every lease. Is it below market? Expiring soon? Is the tenant creditworthy? They will "stress" the income, often applying a vacancy and collection loss factor to the proforma rent.

Phase 2: The Borrower Underwriting (The "Sponsor" Test)

1. Financial Statements: 2-3 years of personal and business tax returns, a personal financial statement (listing all assets/liabilities), and bank/brokerage statements.
2. Global Cash Flow Analysis: They don't just look at the property. They add up all your income (salary, other property income) and all your debt payments (personal mortgage, car notes, other property debt) to calculate a global DSCR. You must pass this test too.
3. Resume & Experience: They'll review your real estate experience and may call references on past deals.
4. Background Checks: Credit check, criminal check, and litigation search.

Phase 3: The "Box" is Checked & Priced

Once all reports are in and the numbers are crunched, the loan committee decides. They slot the deal into a risk category (e.g., "Low-Risk Multifamily, Strong Sponsor") and apply a market-based spread to the benchmark to arrive at your rate.

Your Action Plan to Get the Best Rate

1. Prepare Your "Borrower Resume": Clean up your credit. Organize your financial statements. Write a one-page bio highlighting your experience.
2. Strengthen the Deal Before You Apply: Can you sign a new, longer-term lease? Can you put 35% down instead of 25%? These actions directly lower the lender's risk.
3. Get Your Numbers Right: Have a rock-solid, conservative proforma. Anticipate their adjustments.
4. Shop, But Don't Spray: Choose 2-3 lender types (a local bank, a credit union, a mortgage broker) and give them a complete, professional package. A well-presented deal gets better attention and terms.
5. Understand the Trade-Offs: A slightly higher rate from a local bank that can close in 45 days might be better than a lower rate from a slow, bureaucratic institution if your purchase contract is tight.

In commercial real estate, the rate isn't just a number. It's a direct reflection of how the lender sees the risk of you and your deal. Your job is to make that risk as small and as obvious as possible. Do that, and you'll be speaking their language—the language of a lower spread.