Underwriting vs Comping - They're Different
Comping and underwriting are often misunderstood and incorrectly used interchangeably. Both are essential skills that investors must be familiar with, or they risk losing money on bad deals. You can either develop these skills on your own or outsource the work to others to give yourself the time to build and scale your business.
We'll discuss both processes and why it's important to understand the difference between them.
What is Comping?
Comparative market analysis (CMA) is a summary of recent sales, purchases, or current listings of real estate that closely resemble the property you are interested in. These are used primarily to estimate a price. When measuring the value of a property, specific metrics are used for comparison purposes including square footage, location, and features. While there is no standardized process for a CMA report, many states do have statutes that require specific information included in the report.
What is Underwriting?
Underwriting is the process of assessing and analyzing a project's future cash flow potential and ability to generate income with the goal of minimizing risk. The underwriting process will show you what you need to know about both the borrower and the property in which you are interested in investing. To evaluate the potential cash flow for a real estate investment opportunity, underwriters will analyze factors including entry and exit cap rate, rent and expense growth, vacancy rate, financing terms, and capital expenditure reserves.
It's crucial to acknowledge that cash flow analysis is usually conducted within a specific timeframe, and market fluctuations can occur. For example, while long-term rentals often provide stability, short-term rentals like Airbnb face the risk of entirely disappearing if regulations are introduced that prohibit them in a particular jurisdiction.
So what's the difference?
While comping and underwriting are complementary, they serve distinct purposes in assessing a potential investment. Comping helps you understand what a property is worth in the eyes of the market. On the other hand, underwriting guides you in assessing an investment's income-generating capabilities and financial feasibility. Additionally, comping requires adherence to standards with some room for art. Conversely, underwriting has no regulation and is artistic (although a few flexible rules are typically followed - check out the Straight Outta Compin’ comping rules by Jamil Damji for a good video breakdown).
Our Tips and How We Can Help
Real estate investors must have a solid understanding of both coming and underwriting to avoid entering bad deals that can lead to financial losses. If you are not confident you understand either process well, consult a trusted professional to help you. We say trusted because fraud and misrepresentation do sometimes occur with CMAs and appraisals, so it's always important to do your due diligence and check licenses and qualifications before deciding to work with someone.
Additionally, while you can rely on industry and market standards, you should keep a list of your own standards and criteria to help evaluate your potential investments. This is where we can help. We consult with investors to build their specific lending and underwriting criteria and set up systems and processes. Reach out to us today to inquire how our services can help you plan your investment road map.
Sources:
Understanding Commercial Real Estate Underwriting | Flagship Bank MN (flagshipbanks.com)
What Is Comparative Market Analysis (CMA) in Real Estate? (investopedia.com)
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