3 Most Important Aspects of Underwriting

Here’s your underwriting survival guide – These 3 categories are most important!

Underwriting is all about using the data we have available today to make educated decisions and assumptions about the future.

I want to break down underwriting into 3 categories today. These 3 sections of your underwriting model have a dramatic impact on the project and investor returns.

Getting these categories correct in your underwriting is critical.

Let’s breakdown the 3 most important categories when underwriting a potential acquisition…

1. Projected Rents

Yep, you guessed it. I had to start off the discussion with projected rent amounts.

Your rent amounts have a huge impact on the overall returns of a deal. For example, if you are projecting to achieve a $200 rent increase, you should be 110% sure this is possible based on the data available.

Even getting a rent premium $25 less than expected can have a huge impact (for the worse).

Solution: Verify your rents with a property management company, see if the household income can support the rents, verify what your comps are getting, and use third party data sources like Costar.


2. Financing

Real estate is a highly levered asset. Therefore, leverage makes a huge difference in your returns.

This can be good or bad.

Make sure you are modeling the exact amount of proceeds the lender is willing to provide. After receiving a term sheet, this amount could be different from your original underwriting. The exact LTV or LTC percentage can make a significant difference in your underwriting.

Other fees like rate cap fees, origination, and extension fees should also be shown in your sources and uses.

Solution: Lender relationships will come in handy here. A quick turnaround on a term sheet can help determine if your deal makes sense or not based on accurate debt terms.

Larry Wilemon with Walker & Dunlop is a great resource.

Contact Larry here: [email protected]


3. Assumptions

I could write a book on assumptions but I’ll point out a few critical ones you need to know.

Operating expenses have a direct impact on your net operating income. So if you are underwriting a property with $1,200/unit for payroll expense but your property management company says it will be closer to $1,500/unit, as you can imagine, this will hurt your returns.

Market rent growth assumptions are compounding in nature and should be used cautiously. Read my past issue about organic rent growth here.

Economic loss such as bad debt, concessions, and physical vacancy should also be in line with your business plan and the mar

Solution: Verify your assumptions early with 2 or even 3 different property management companies. Use resources like Consumer Price Index, Costar, City Data, and RealPage for reliable data sources. Most of all, focus on the under-promise and over-deliver approach with your assumptions!