Escrow and Impounds

Three accounts, not one

Borrowers use "escrow," "impounds" and "reserves" as if they were the same word. Lenders do not. On a commercial loan they usually mean three separate accounts, funded on different schedules and released under different rules.

• Tax and insurance escrow. One twelfth of the annual property tax bill and one twelfth of the annual insurance premium, collected every month. The lender pays the bills directly when they arrive. This is money you would have spent anyway; the lender is controlling the timing, not adding a cost.
• Replacement reserve. A monthly deposit set aside for the roof, the parking lot, the HVAC units — capital items that wear out on a schedule nobody controls. Quoted per unit per year on apartments, or per square foot per year on commercial buildings. You get this money back by submitting invoices for completed work and waiting for reimbursement.
• Tenant improvement and leasing commission reserve. Office, retail and industrial only. Cash held back to build out space for the next tenant and pay the broker who finds them. It is sized off the lease expiration schedule in your rent roll, so a building with several near-term rollovers carries a heavier reserve than one with long leases.

Worked example

A 25-unit apartment building with a $2,000,000 loan at 6.75% on a 30-year amortization. The principal and interest payment is about $12,972 a month. Here is what the lender actually pulls from the account:

• Principal and interest — $12,972
• Property tax escrow — $38,400 a year, so $3,200 a month
• Insurance escrow — $14,400 a year, so $1,200 a month
• Replacement reserve — $300 per unit per year across 25 units, so $625 a month
• Total monthly debit — $17,997

The escrow portion is $5,025 a month, or $60,300 a year. That is roughly 39% on top of the loan payment itself. A borrower who modeled $12,972 and saw $17,997 leave the account did not misread the interest rate. They read half of the obligation.

There is a day-one cost too. Lenders fund the escrow at closing with enough months to cover the next bill: if the tax installment is due in four months, expect to deposit around eight months of taxes — about $25,600 here — plus a few months of insurance, at the settlement table. On many purchases that deposit is the largest line item after the down payment.

What it means for you

Taxes and insurance already sit inside net operating income, so escrowing them does not change the economics of the deal. Reserves are a different animal. A replacement reserve is real cash leaving your account every month, and on most seller-supplied financials it was never subtracted at all. Underwrite off a seller's expense line and your actual cash flow is lower than your model by the entire reserve.

Ask for the full escrow and reserve schedule at term sheet stage, not at closing. It is a fair question and every lender can answer it. When you start a commercial real estate loan application with us, those figures go into the cash flow model before you commit, alongside the rest of the CRE loan requirements.

What to watch for

• Reassessment after a sale. In many jurisdictions the property is reassessed at your purchase price. Your first-year tax escrow is then based on a bill nobody has seen yet, and the shortfall gets trued up later — often as a lump-sum catch-up demand in year two.
• Insurance escrow moves fastest. Premiums in coastal and wildfire-exposed markets have repriced sharply. A renewal that jumps raises your monthly escrow immediately, and there is no notice period that helps your cash flow.
• Reserve draws are reimbursements, not advances. You pay the contractor first, then submit invoices and lien waivers, then wait — commonly 15 to 30 days. Budget the working capital to float the job in between.
• Waivers exist, at a price. Experienced sponsors sometimes negotiate away the replacement reserve, or convert it to a springing reserve that only activates if debt service coverage drops below a set level. Ask for it in the term sheet. It is close to impossible to add after closing.

What are impounds on a commercial loan?

Impounds are the monthly amounts your lender collects alongside principal and interest to cover property taxes and insurance, held in an account the lender controls and pays out of. On commercial loans the term often gets stretched to include replacement and tenant improvement reserves as well, which behave quite differently, so it is worth asking which accounts a quote actually includes.

Can you waive escrow on a commercial mortgage?

Occasionally. Tax and insurance escrow waivers are uncommon and usually reserved for low-leverage loans with a strong sponsor and a long track record. Replacement reserve waivers or springing structures are more negotiable. In every case it is a term sheet negotiation, not a closing-table request.

Do escrow payments count toward my DSCR?

Taxes and insurance are already deducted as operating expenses when net operating income is calculated, so they are inside the DSCR math. Replacement and tenant improvement reserves may or may not be, depending on the lender. Ask directly whether reserves are underwritten above or below the NOI line, because it changes the loan amount you qualify for.