What Is Senior Debt in Commercial Real Estate?

Fixed-rate senior debt locks in an interest rate for the full loan term, giving the borrower certainty over debt service regardless of where benchmark rates move, which suits stabilized properties with long-term leases where predictable cash flow matters most. Floating-rate senior debt, typically priced as a spread over SOFR, moves with the market, which suits transitional properties where the loan term is short enough that rate volatility has less time to compound.

Floating-rate loans usually require an interest rate cap as a condition of closing, limiting the borrower's exposure if rates rise sharply, and the cost of that cap itself varies with market expectations for future rate movement, sometimes adding a meaningful upfront expense to an otherwise attractively priced floating loan that borrowers should factor into their all-in cost comparison.

Some senior loans convert automatically from floating to fixed at a predetermined point, giving a sponsor the benefit of lower floating-rate carry during a transitional period followed by rate certainty once the property stabilizes, though this conversion feature typically comes at a modest premium over a purely floating structure.

Non-recourse senior debt limits the lender's remedy on default to the property itself, without a general claim against the borrower's other assets, and is standard on most institutional CRE loans above a certain size. Even a non-recourse loan, however, includes carveout provisions, sometimes called bad-boy carveouts, that create personal liability for specific bad acts like fraud, misappropriation of rents, unauthorized transfers, or environmental violations.

Some carveouts are full recourse triggers, such as filing for bankruptcy on the property-owning entity, while others are limited to the actual loss caused by the bad act, so the specific carveout language, not just the existence of non-recourse debt, determines a sponsor's real exposure and is worth careful legal review before signing.

Senior loan agreements typically include financial covenants, such as minimum DSCR and minimum occupancy, reporting covenants, such as monthly or quarterly financial statements, annual budgets, and rent rolls, and operating covenants, such as maintaining insurance, paying taxes, and keeping the property in good repair. Breaching a covenant does not automatically mean default in most agreements; many include cure periods and escalating remedies before acceleration becomes available to the lender.

Sponsors who negotiate covenant levels realistically against a downside scenario, not just the underwritten base case, avoid technical defaults triggered by a temporary dip in performance that does not actually threaten the loan's ultimate repayment, since a covenant breach can trigger cash management or additional reporting burdens even when the loan itself remains current.

Insurance and tax escrow requirements are also worth reviewing closely, since most senior lenders require monthly escrow deposits for property insurance and real estate taxes, held by the lender and disbursed directly when bills come due, which reduces the borrower's flexibility over cash timing compared to paying these expenses directly, even though the total dollar cost is the same.

As an illustration, a sponsor compares two senior loan quotes on the same $10,000,000 acquisition. A bank offers $6,500,000, 65% LTV, at 6.25% fixed for five years, fully amortizing over 25 years, closing in about 60 days. A debt fund offers $7,500,000, 75% LTV, at 8.5% floating, interest-only for two years, closing in about 25 days.

The bank loan produces lower debt service and a lower rate but requires more equity and a longer closing timeline; the debt fund loan produces higher leverage and faster execution but at meaningfully higher cost, illustrating the tradeoff sponsors weigh constantly between cost of capital, leverage, speed, and structural flexibility rather than choosing a lender on rate alone.

Fixed-rate senior loans commonly include a prepayment penalty structured as yield maintenance, a formula that compensates the lender for the interest income lost if the borrower repays early, calculated against the difference between the loan's rate and current market rates for a comparable remaining term. Floating-rate loans more often use a simpler step-down penalty, a flat percentage that declines each year, or no penalty at all after a short lockout period.

Sponsors planning an early sale or refinance should model the yield maintenance cost at several possible exit dates before closing, since the penalty can be substantial in a falling rate environment and materially change the economics of an early exit compared to holding to the scheduled maturity.