The interest reserve covers the gap between in-place NOI and required debt service while the asset stabilizes. Sized as projected coupon ( rate cap strike plus spread ) times the lease-up months times the funded loan, less in-place NOI. Held in a lender-controlled account, drawn monthly to bridge the shortfall.
Sizing the interest reserve and what to negotiate at term-sheet
Mechanics: the bridge lender models monthly debt service for the lease-up window (typically 12 to 24 months on multifamily value-add, 18 to 36 months on office/retail repositioning, 12 months on hotel PIP). Subtract projected monthly NOI in each month. The cumulative shortfall is the funded interest-reserve amount.
Rate inputs: floating-rate bridge debt service is computed using the lender's required strike on the rate cap (typically 1.0% to 2.0% above the spot index at closing) plus the loan spread. Sponsors who buy a tighter cap get a smaller interest reserve; sponsors who buy a wider cap get a larger one, the trade is rate-cap premium against funded reserve.
Funded vs. unfunded: lender-controlled funded reserves earn interest on deposit at money-market rates and are drawn monthly. Unfunded reserves (covenant-only) appear only on the strongest sponsor deals and are unusual on transitional CRE. Most bridge lenders insist on funded reserves on transitional paper.
Recapture mechanics to negotiate: when stabilized NOI covers debt service for 3 consecutive months at a defined DSCR (typically 1.10x to 1.20x), unused reserve funds should release back to the borrower. Standard lender drafts trap the cash; sponsor-friendly drafts release it on a defined cure. This is a high-value redline.
Sources
- Secured Overnight Financing Rate (SOFR) · Federal Reserve Bank of New York · daily
- Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS) · Board of Governors of the Federal Reserve System · 2026-Q1
- Quarterly Survey of Commercial/Multifamily Mortgage Bankers Originations · Mortgage Bankers Association · 2026-Q1