Multifamily Real Estate Underwriting

Underwriting is the process of evaluating the financial viability of a potential real estate investment opportunity. This includes analyzing the cash flow and expenses of a property, as well as taking into account market trends and economic factors. Underwriting a multifamily property requires a thorough understanding of the property's operating history, as well as projections for future performance.

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You may have heard multifamily operators refer to their underwriting as being conservative, but what exactly does that mean? Underwriting conservatively means taking a cautious approach when analyzing a property's financials. This involves assuming that the property will not perform at its highest potential, and accounting for potential risks and unforeseen expenses. By underwriting conservatively, investors can ensure that they are not overestimating the potential return on their investment. Below are the top places where we practice conservative underwriting to ensure we don't overpay for a property and that we protect our investors' money from potential risks.

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Rent and Expenses

Even small increases in rents can make a multifamily deal more profitable. This is why it's important to take extra care not to overestimate the current market rents or assumed future rent growth. Rent growth assumptions over 3% annually need to be very well founded and justified by in-depth market research. That being said, 1% - 3% is a conservative organic rent growth assumption in the current climate, depending on the market where the investment is located. In terms of expenses, it's usually in an operator's plan to decrease the property's overall operating expenses, however, when underwriting the deal, we always assume that the expenses will increase.

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Property Taxes

Understanding property tax assessments, the rate of increases, and how it will have an effect on the future assessed value is crucial. An unexpectedly high tax bill can affect returns significantly. We assume the tax bill will jump significantly and be based on our purchase price of the property.

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Capitalization Rate

A lower capitalization rate at the time of sale means a higher sales price. Conservatively underwriting a multifamily deal includes assuming that the capitalization rate will be higher when exiting the deal than it was when the property was bought. An increase of 5 basis points (0.05%) per year is commonly used in the industry.

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Time Requirements

With value add deals, it's important not to underestimate how long it will take to reposition the property and start achieving the projected rents. These types of increases don't happen overnight. Careful review and analysis of the rent roll will give a good idea of when each lease will expire and provide a timeline of how many rent increases can be achieved within a given period of time. The same goes with renovation timelines; keeping them realistic will give a more accurate idea of when higher rents will be achieved.

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Operating Reserves

In addition to money raised for the value-add aspect of the project, operating reserves should also be included when underwriting. Operating reserves serve as additional funds to be used for any unexpected expenses that may arise. They should be included as an expense and assumed that they will be spent each year.

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While being this conservative will no doubt rule out many deals, it will ensure that we only invest in deals that will still work when there's unexpected property issues, or changes in the economic and financial landscapes.