#26+++
Local knowledge should supersede online data.
After years of investing in the same area, we know parts of Ohio like the backs of our hands. We have seen trends and can see new commercial + luxury apartments being built that don’t even appear online just yet.
Most experienced investors appear to be pulling numbers out of thin air but in reality, they just know that particular market well.
If you’re starting out in apartment investing, stick to what you can find online and the baseline assumptions. Once you develop a deep mastery of underwriting and of a region, you’ll know the ins and outs like the experienced investors today.
#27+++
Use commercial retail as an indicator of tenant class.
Dollar stores have a specific business model to build in under-served communities.
They typically pop up in neighborhoods that have lower median HHI and less access to typical grocery stores or retail stores like Walmarts and Targets.
Having a dollar store or two around a property is perfectly normal but if you’re looking at an asset surrounded by dollar stores on all sides, make sure you’re matching your business plan with the tenant demographic.
Are you planning to buy this asset and provide affordable, clean, modern housing for this tenant base? Awesome.
Were you going to spend $75k to put in a saltwater infinity pool and give away Equinox memberships to new tenants who sign leases? Best to reconsider your business plan.
The same rule applies in multifamily real estate as it does in any tech company offering a product - just because you build it, doesn’t mean customers will flock to you. Make sure your business plan matches the target tenant (customer) demographic.
#28
Underwriting is the best way to truly learn real estate.
Why? Because in order to fully underwrite, you need to know each piece of the stabilization journey.
What may look like a single skillset to some in “underwriting” is actually various topics combined. In order to underwrite a property you need to know…
If you’re purely a deal-finder, you don’t absolutely need to know any of the above.
If you’re raising capital, you can get away with reiterating what someone else told you or deferring to another team member
Only the underwriter has to know in-depth every answer since it’s his/her responsibility to calculate everything. Underwriting is a crash course in understanding the intricacies of real estate.
#29+++
The best spreadsheet to use
A lot of aspiring underwriters ask me about the best spreadsheet to use.
My suggestion: using a spreadsheet as an underwriter is like using a hammer as a contractor. Sure, everyone has their favorite but if you want to be a true master, the tool matters much less than the expert.
Ultimately, you’ll want to use the spreadsheet that your team is most used to seeing. The goal is to maximize the process and if you have to walk your team through a brand new spreadsheet every time, it’ll get chaotic.
We at Compounding Capital have our own called Nucleus but a number of masterminds and groups have their own.
To start, focus more on learning the intricacies of how the spreadsheet functions (seriously, just pick one) and how the various levers impact returns and you’ll be able to transition between spreadsheets easily enough in the future.
#30
My biggest tip for underwriters
Understand incentives. I market and sell as much as I get marketed and sold. It is your job to always be critical of every individual’s motivations.
Underwriting involves sifting through a ton of data that may or may not be biased in one way or another. You ask the same question to different people and they’ll give you different answers.
How much rent can I charge for this unit?
A broker wants that deal to close so they get their commission. They’ll tell you that rentals are booming, that you’re in a beautiful / amazing / fantastic area, and that rent projections should be $1750.
A property manager will never care about your property as much as you do. They’ll tell you that they can get $1500 in rent when you’re vetting PMs. After hiring them and having the unit sit vacant for 3 weeks, they’ll suggest you lower your rent to $1350 to better match current market demand.
A partner that needs an acquisition fee to pay their bills will care more about buying that next deal than they will about stabilizing this one. They’re not sure how much rent you can charge but… actually, can you underwrite this other deal they just found? It’s got a lot of potential.
There is no way for me to give you an exhaustive list of which numbers to trust and which numbers to question but at the end of the day, the source of where you get that data from matters a tremendous amount.
Do I trust people? Of course, everyday! But I am skeptical by nature and in the wild west of real estate… that skepticism has served me well.
And that wraps up 30 days of underwriting tips. Hope some people were able to derive value from these.
#23
Here’s what you need to collect before you underwrite:
T12 = trailing 12 that shows the performance of the property over the last 12 months. Sometimes only a T9, T6, or T3 are available.
rent roll = latest log of collected rents. Shows what current tenants are paying, the seller / broker’s estimate of current market rents and additional charges passed off to tenants.
tax bill = latest bill from the county / city that shows how much was paid in taxes. Usually has a breakdown of the millage rates for the county, school board, city, fire department, etc. Use this to estimate a reassessment of taxes.
Offering memorandums may sometimes be helpful but you have to remember that they’re mostly filled with marketing. The sellers want to portray their property & location in the best light possible so it’s best to do your own unbiased research and ignore the hype.
#24
Everybody is a conservative underwriter.
Don’t get caught in the echochamber of “conservative underwriting”. No one in multifamily will openly admit that they are reckless - it’s not good marketing.
Underwriting is about understanding the various levers that allows you to make a deal work. Debt, rent increases, operational efficiencies, tax reassessment deferral, CapEx - these are all levers. There WILL be a section of the business plan where you will have to be aggressive based on the competitive advantages that you have.
Throwback to post #4: “conservative” is entirely subjective. It’s more important to dig into the underwriting and make sure you’re aligned with your partners than assume your definition of being risk-averse matches someone else’s.
#25+++
Make sure your business plan matches the tenant demographic.
The average HHI monthly income of your neighborhood / MSA should be 4x the total rent you’re trying to charge.
Example: if average HHI is $50k, don’t expect more than $50,000/12/4 = $1041 in rent. If you want to be a bit more aggressive, you can divide by 3 instead.
This is the formula that most property managers use to vet tenants.
If your business plan hinges on being able to charge $2000 per unit since you’re paying $150k / d but the HHI of your area is $40k… you’re trying to fit a square business plan into a circle tenant demographic.
#19
Being an underwriter is accepting probability.
A 99% chance of success, still means you fail 1% of the time.
As an active underwriter and an active asset manager, I am acutely aware of how my projections transform into reality. Sometimes my projections are scary accurate, other times I wonder what the hell I was thinking.
There is exactly a 0% chance that ALL of your pro forma projections will come true so accept that parts of your plan will go wrong even if you made the right decision based on the info you had at the time.
Get a team, find colleagues and develop a feedback loop that’s able to give you the hard truth when it’s most needed. Asking a fellow unbiased underwriter on whether or not they would’ve made the same decision as you will help refine your radar for when you should fix a mistake or chalk it up to probability.
#20
Estimating closing costs is one of the only times that I choose to take the “easy path”.
I used to manually calculate the closing costs by adding appraisals, title fees, lender fees, seller demands, etc. but overall, closing costs are a one-time relatively small payment.
Don’t over-analyze. As long as you’re building cushion at every step of your underwriting, there’s no point in trying to get your closing costs accurate to the dollar when it’s a triviall amount.
2% of purchase should be enough for most local banks or long-term lenders.
Hard money, bridge or any short-term loan needs 4-5%.
#21
Tax reassessments often make or break a deal.
A large portion of counties in the US reassess taxes at sale. More importantly, taxes get reassessed at different cycles across the country.
Make sure you’re pulling the latest tax bill, calling the local tax office to understand reassessment cycles, and if needed, paying a tax consultant to give you a professional estimate of where your taxes will reassess.
#22+++
What is cap rate?
Cap rate = net operating income divided by the asset value or the rate of return of the asset if you were to buy fully in cash.
Market cap rate = the average cap rate you should expect in that given market across similar properties
A market cap is essentially a proxy for how competitive a local market is. Higher cap = better for buyers and lower cap = better for sellers.
Cap rates are useful for brokers or lenders who need a frame of reference to compare their hundreds of similar deals but for you as an investor, cap rates are meaningless.
Predicting your future cap rate at sale is near impossible and any amount of value-add you inject into the asset will drastically alter the NOI.
The safest thing you can do is to assume that the market will continue to worsen as you hold an asset. After X years, you’ll be selling in a terrible market for sellers. This way you project returns based on a worst case scenario.
#16
My biggest struggle in learning how to underwrite was getting an idea of real-world benchmarks.
Plugging in numbers into a spreadsheet is easy enough - there are plenty of video tutorials on Youtube to get you through the technical piece but…
How do I estimate my budget for repairs and maintenance when I have no baseline? I don’t know what I don’t know.
My advice? Start talking to property managers in your local area. They’re the ones who will be taking care of the day-to-day operations so they have a good grasp of how much you need to set aside.
Even better, start networking with other underwriters - join masterminds, facebook groups, follow people on Linkedin and as you get opportunities to see other people’s underwriting, you’ll absorb benchmarks over time.
#17
My biggest tip on improving your underwriting skills - pay someone for their time to get 1-on-1 coaching.
I’ve spent tens of thousands on real estate education across masterminds, courses, bootcamps, events, etc. but I took my underwriting to the next level with personalized coaching.
Most masterminds and courses cover the entire spectrum of multifamily investing but I knew underwriting was going to be my superpower and needed a specific feedback loop for this particular skill. It took me a number of months but I eventually found a few underwriters who agreed to trade a bit of their wisdom for an hourly rate.
I offer 1-on-1 guidance not because I plan to get rich (I didn't take a gigantic leap into full-time investing only to give myself another day job)… but because it's something I wish I had. The few hundred dollars I gave for their experience was undoubtedly the biggest ROI I've ever had.
Workshops and books and free events are great but it’s way more efficient to get specific questions that pertain to a specific deal answered.
#18
Avoid sunk cost fallacy when underwriting.
Sunk cost fallacy - A person refuses to give something up because he/she has invested heavily into it
You put down $20k of hard EMD and spent 45 days doing due diligence only to find your numbers don't work in the end.
So what should you do? Dig in as deep as you can and stretch your creativity but in the end, if it doesn’t work… walk away.
We've lost tens of thousands in EMD because we had to make competitive offers but in the end the due diligence revealed too many flaws.
Channel your inner robot and take a look at your situation with completely objective goggles. Would you rather lose $20k and call it the cost of being in business? Or would you rather buy a bad deal and potentially lose 10x that over the next 5 years of torturing yourself?
Don’t let an attachment to a deal lead to more headache down the line.
#12
Differentiating vacancy in your underwriting is important. A lot of investors lump “vacancy” as one percentage but it’s multiple strategies rolled into one. Here’s an overview of the differences.
Economic vacancy = catch-all term that describes the different in amount you SHOULD be getting through your tenants and the amount you are getting
Loss-to-lease = The difference between rent today and market rent. LTL usually exists because the current owner decided not to increase their rents as much as market rents increased. Over time, this adds up.
Concessions = discounts or incentives you give to tenants in order to entice them to rent your units. Usually a month of free rent.
Physical vacancy = % of income lost simply because you have empty units throughout the year. It takes time to find tenants and/or to renovate units.
Non-revenue = units that are not rented out because they serve a specific purpose. Sometimes you convert an active unit into an office for your employees or convert an active unit into a model unit to show prospective tenants.
Delinquency = amount of income that tenants owe because they are behind on rents. Delinquency is for money that you reasonably plan to get back.
Bad debt = income from tenants that you don’t plan to get back. You usually have at least a small amount of bad debt since it would be more expensive for you to try and recoup this amount.
#13
Data analysis is an undervalued skillset and underwriting in real estate is no different. After ten years as a data professional, I’ve learned that everyone says they love data-driven decisions but ask those same people to give a bit of money (or equity) for that skillset and they’ll say “oh, I’ll just do it myself”. For any aspiring underwriters, get ready to wear multiple hats because developing a portfolio purely with underwriting is very, very difficult.
On the other hand, underwriting is merely making assumptions about the future. Yes, it takes time to develop the skillset but there’s really no risk involved. There’s a big commitment difference between spending 5 hours creating a business plan and spending 5 years stabilizing a property.
Whether or not I feel underwriting is undervalued doesn’t change the current “market value” of the skillset. Do you think underwriters are fairly compensated today?
#14
RUBS = ratio utility billing system. If you do not have individually metered apartment units (so you don’t know how much exactly each tenant uses), you can charge a flat number for the water / gas / electricity costs of running your apartment. The amount you charge is typically calculated based on number of tenants on the lease and/or the size of the units themselves.
Friendly reminder to check if the amount of projected RUBS in your business plan is over the actual amount of utilities that the property incurs.
You cannot make a profit from billing back utilities unless you have a specific ability / license to resell utilities.
If a T12 says the current owner is charging $80 in RUBS but the expenses only add up to about $60 per tenant in utility charges, there's a discrepancy somewhere.
#15
If you’re starting off in real estate, don’t get caught in the analysis paralysis of not knowing where to invest. North Carolina, Texas, Florida are amazing places to invest but if you have no network in those regions and you’re 800 miles away, it’s going to be extra difficult to break into that level of competition.
My personal opinion? Start with somewhere where you do have a competitive advantage. Maybe it’s where you live right now or where you grew up (but still visit frequently). If you know the local streets better than the average investor and/or you can view properties to make an offer during the same afternoon, you have a much better chance of taking down that first deal.
You're always welcome to derive inspiration from anything I share. The actual deck is something I worked very hard on and only share it with deal partners and/or students.
Go the extra mile to focus on how you tell the story of your deal. A professional deal presentation helps elevate your underwriting findings.
The original slide doesn’t do a good job of explaining what syndication is. If I’m a passive investor, I need more than a simplified graphic.
I love analogies as a data visualization tactic since they help relay a complex subject by tying it to something that’s more familiar. We gear this analogy specifically for our audience - corporate professionals. Let’s compare a syndication to the basic skeleton of any company and now anyone who’s worked at a job or invested in stocks has a better understanding.
#10
Go the extra mile to focus on how you tell the story of your deal. A professional deal presentation helps elevate your underwriting findings.
The original slide is messy. There’s too many boxes, too many icons, too many colors, too many numbers.
Do the icons add anything? Not really so let’s remove them a first step.
The numbers are arbitrary and are meant to paint a picture. Instead of writing out 9/10, 2/10, 1/10, let’s visualize them as a bar being filled. Now, a potential investor takes away the same idea without having to process the fraction.
#9
Go the extra mile to focus on how you tell the story of your deal. A professional deal presentation helps elevate your underwriting findings.
The original slide is basic - there’s nothing particularly wrong with it but if you have too many of these slides, your story seems stale. The icons really serve no purpose and add nothing to the story. You’re already using bold headlines and spacing to differentiate the concepts.
Something as simple as making the font bigger and creating a hierarchy so the slide makes more sense elevates the story. There’s no need to get fancy - but even a basic reformatting goes a long way.
My posts keep getting blocked so my tips have been a bit backlogged. Trying my best to not include any outside links or anything that can be taken as advertising.
#4
Not all technical people are the right underwriter for you. Just because someone is an engineer or an analyst doesn’t mean they have the same risk tolerance. If an underwriter is okay with assuming 7% rent growth but you want 4%... you’re not on the same page.
My advice? Develop a basic understanding of real estate numbers so you can vet your underwriters and make sure you’re working with the right partners who have the same risk profile as you.
I’ve seen underwriters self-label as “conservative” only to uncover that they were way more aggressive than I was. I’ve seen “aggressive” underwriters build in double the amount of cushion. Don’t assume everyone is defining these terms in the same way and educate yourself a bit to better protect your investment(s).
#5
A single number that you hard enter and then forget to change… can drastically impact multifamily returns. Even experienced underwriters (myself included) make the mistake of forgetting a cell.
My advice? Every time you want to underwrite, use a BRAND NEW copy of your underwriting model (hopefully you have a clean copy). That way you minimize your chances of letting a previous deal’s hard-coded numbers ruin your projections.
#6
“I’ll buy for $100k a door, do $20k a door of renovations, and sell for $150k a door.”
Underwriting can be overwhelming but don’t oversimplify the process. You cannot mold a complex skillset to your comfort level. I promise you that modeling isn’t rocket science but using one formula to buy a multi-million dollar asset is borderline dangerous.
If underwriting was as simple as 100 + 20 < 150, wouldn’t everyone be real estate millionaires? Rules derived after multiple deals and a meticulous understanding of your local market are powerful and that’s the ultimate goal.
If you want to buy an apartment complex with one formula to start though, you might as well be gambling…
and flying to Vegas is a lot easier than buying real estate.
#7
A mastery of numbers is useless without an ability to communicate findings. I learned throughout ten years as a data scientist that most of the world doesn’t care about your r-squared value. 😥
You know who cares about technical jargon and statistics lingo? Other data people… but unless you plan to only invest / work with data people, you need to learn how to distill complex analytical findings into plain English.
Data storytelling tip: Use simple charts and graphs. Only pie, donut, line, bar, or area charts. Nothing 3D, nothing that has complex animation, nothing with shadows and arrows and highlights.
You may think more data points and colors make your points clearer but in reality, more is distracting and confusing.
#8
Differentiating rent increases in your underwriting is important. A lot of investors lump “rent increase” as one percentage but it’s multiple strategies rolled into one. Here’s an overview of the differences.
Rent today = rent collected today (usually by the seller on the T12)
Additional income = additional charges you can pass on to tenants: Pet rent, RUBS, laundry, package lockers, carports, late fees, etc.
Market rent = rent you COULD collect today with little to no renovations. The difference between rent today and market rent usually exists because the current owner decided not to increase their unit rents as much as market rents increased. Over time, this compounds and leads to “loss-to-lease”.
Rent premiums = the additional rent increases you’d be able to get with a significant transformation of the unit / property. This is usually the pro forma rent that you’re aiming for in your underwriting.