The same building, the same loan, the same test date: one ratio looks back and passes, the other looks forward and fails.
Projected ICR breaches first whenever income is known to be leaving, because it counts only rent contractually payable over the next twelve months, while historic ICR averages the last twelve. On an illustrative 20,000,000 loan where a tenant paying 900,000 leaves in month 4, the building tests at 1.92x historic but 1.33x projected against a 1.75x covenant on the same date. The historic test does not fail until month 9.
Worked in full in How to Read a Real Estate Loan Agreement by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
A multi-let office earns 2,400,000 of rent. The largest tenant, paying 900,000, has exercised its break and leaves at the end of month 4. The loan is interest only and fixed through a swap, so interest is the same in both tests and only the income differs. Many European real estate facility agreements test both ratios on each quarterly date, each at 1.75x here. All figures are illustrative.
| Item | Value |
|---|---|
| Rent: tenant A / other tenants | 900,000 / 1,500,000 |
| Irrecoverable costs, let building | 100,000 |
| Extra costs on tenant A's space once empty (rates, service charge) | 150,000 |
| Loan / fixed all-in rate | 20,000,000 / 6.0% |
| Annual interest | 1,200,000 |
| ICR covenant, historic and projected | 1.75x |
At 1.75x the income must be at least 2,100,000.
Historic NRI = rent received in the last 12 months − irrecoverable costs = 2,400,000 − 100,000 = 2,300,000
Historic ICR = 2,300,000 / 1,200,000 = 1.92x: passes
The projected definition counts rent only while it is contractually payable. Tenant A pays for four more months; its unit then sits empty, and the costs that tenant used to pay through the service charge fall on the landlord. A typical definition does not let the borrower assume a re-letting or include the estimated rental value of vacant space.
Other tenants: 1,500,000
Tenant A, months 1 to 4: 900,000 × 4/12 = 300,000
Less irrecoverables 100,000 and void costs 150,000 × 8/12 = 100,000
Projected NRI = 1,500,000 + 300,000 − 100,000 − 100,000 = 1,600,000
Projected ICR = 1,600,000 / 1,200,000 = 1.33x: breach
In a monthly model the two tests are =SUM(OFFSET(NRI,-11,0,12))/SUM(OFFSET(Int,-11,0,12)) looking back and =SUM(OFFSET(NRI,1,0,12))/SUM(OFFSET(Int,1,0,12)) looking forward.
| Test date (month) | Historic NRI | Historic ICR | Projected NRI | Projected ICR |
|---|---|---|---|---|
| 0 | 2,300,000 | 1.92x | 1,600,000 | 1.33x |
| 3 | 2,300,000 | 1.92x | 1,337,500 | 1.11x |
| 6 | 2,125,000 | 1.77x | 1,250,000 | 1.04x |
| 9 | 1,862,500 | 1.55x | 1,250,000 | 1.04x |
| 12 | 1,600,000 | 1.33x | 1,250,000 | 1.04x |
The projected test fails today and keeps failing. The historic test passes for two more quarters, 1.77x at month 6, then fails at month 9 and only reaches the 1.04x the building really earns with the space empty at month 16. Both ratios describe the same building; one is simply three quarters late.
| Tenant A leaves at end of month | Projected ICR today | Projected first fails | Historic first fails | Months of warning |
|---|---|---|---|---|
| 4 | 1.33x | month 0 | month 9 | 9 |
| 10 | 1.77x | month 3 | month 15 | 12 |
| 14 | 1.92x | month 6 | month 18 | 12 |
With quarterly testing the projected covenant fails nine to twelve months before the historic one: twelve when the lease end is seen coming, nine here only because it is already close. A borrower that watches only the historic ratio, because that is the one the property manager reports, finds out about the breach from the lender.
To restore 1.75x on 1,600,000 of projected income, interest can be no more than 1,600,000 / 1.75 = 914,286. At 6.0 per cent that supports 15,238,095 of loan, so the borrower must prepay 4,761,905, 23.8 per cent of the loan, or re-let the space, or agree a deposit cure if the agreement allows one. That prepayment only cures today's test: the projected income keeps falling as the void months enter the window, and at month 3 the reduced loan tests at 1.46x. A cure that holds through the void has to be sized on the 1,250,000 the building earns with the space empty: interest of 714,286, a loan of 11,904,762 and a prepayment of 8,095,238, 40.5 per cent of the loan. The economics of a deposit against a prepayment are worked in why prepaying to cure a covenant costs eleven times a deposit.
Borrowers model projected ICR as last year's income rolled forward, or include the vacant unit at its estimated rental value on the assumption that it will re-let. The definition usually allows neither. Three words decide the number: whether rent is "contracted" or "projected", whether break dates count as expiries when the break is still only an option, and whether costs on vacant space are deducted. Read them before the first test date, not after the first breach. For the stressed-rate version of the same ratio, see what interest cover ratio lenders require.
If the swap fixes only part of the loan, projected interest uses forward rates or a stressed rate on the unhedged balance, and the projected test can fail on rates alone with no tenant leaving.
The book reads the covenant definitions line by line and what happens when a test is missed, and the free workbook for this case prices the cure options on its own loan.
Projected net rental income for the next twelve months divided by projected interest for the same period. Most definitions count only rent contractually payable, exclude rent from leases that expire or are terminated unless renewed, and deduct costs on vacant space. In the illustrative case it is 1,600,000 over 1,200,000, or 1.33x.
Historic cover confirms what the property actually earned; projected cover gives early warning of income already known to be leaving. In the illustrative case a lease ending in month 4 is invisible to the historic test until month 9, by which time the borrower has lost three quarters of warning.
Solve for the loan whose interest the projected income covers at the covenant level. With 1,600,000 of projected income and a 1.75x test, interest can be 914,286, which at 6.0 per cent supports 15,238,095 of loan. The prepayment is 4,761,905, 23.8 per cent of the 20,000,000 balance, but it cures only today's test; sized on the 1,250,000 earned once the space is empty, a cure that holds is 8,095,238.
This article is one calculation from How to Read a Real Estate Loan Agreement. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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