7 Steps to Multifamily Real Estate Underwriting For Beginners
If you are looking to break into multifamily real estate underwriting for the first time or just looking to advance your existing real estate investing roadmap, read further.
Many people get overwhelmed and over-complicate the process of underwriting. However, we will help you to make it simpler. In this article, we will throw light on seven most important points that you need to consider to your next deal analysis, to make sure that you are evaluating a multi-family deal accurately.
So let’s start this off with the first point and probably the most important piece of what you’re going to be analyzing, in order to begin with the underwriting process.
1. Analyzing the inflow:
The first step to multifamily real estate underwriting is analysing the Rent Roll. You need to put down the list of all the tenants and all of the rent and other charges those tenants are paying. You also need a trailing 12-month of income and expenses, operating statement to make sure that you know, all of the other income items that have been generated at the property. Rent for pets or storage, etc., for instance.
With this you also need to make sure that you can see what kind of vacancy the property has experienced in the past. Assess all positives against negatives. Ask yourself if you feel confident with the in-place base rent and the other income that you might generate from the property.
2. Analyzing outflow:
The next step is to figure out outflow i.e. all the expenses. With this you need to figure out the approximate operating expenses that are going to be borne for the entire duration of the time you hold the property.
Again in this case a trailing 12-month operating statement is what you need to figure out what operating expenses have been and what operating expenses might be there in the future.
Now the biggest wild card in your expenses is likely to be your property taxes because often times property taxes are reassessed upon sale. So make sure that you take that into account — based on the city, county, state and country that you are in, to know what your property taxes are going to be and how that’s going to impact your operating expenses while you hold the property.
3. Figuring out construction and renovation expenses:
Now when you have made your assumptions about what your income and expenses are going to be, the third factor that you need to get into perspective is construction and renovation expenses.
Many multifamily investors will go into a multifamily deal with a plan to renovate the common areas and the interiors, etc. And this certainly comes with associated costs. You need to make sure that you add that to your financial model. That means you want to make sure that you include all sorts of renovation expenses that you might have.
This includes all the hard and soft costs and yes, you can claim renovation premium and push rents up – this will ultimately affect your investment returns.
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4. Figuring out your growth rates and vacancy rates:
Now, once you have clear view of your revenues, your expenses and your construction expenses, the fourth thing that you need is to add your assumptions for growth as well as vacancy rates. So here you need to specifically weigh market rent growth over time.
For instance, if you plan to buy an apartment building in San Francisco, California that has the average rent per unit $2,500 per month. Five or seven years down the road from now that same unit may be renting for $3,000 or $3,500 a month. You should be able to account that in your real estate financial model when you are analyzing a deal. You would also want to factor-in the expenses that you incur during the time a property could be lying vacant.
Do not assume 100 per cent occupancy. Your vacancy rate assumption is going to be based on what you are observing in the market, looking at the comparable properties and how you plan to operate that property.
5. Figuring out post-renovation rents:
The next step is to project the post-renovation rents that you can achieve once you actually complete your renovation.
For instance, if you are buying an apartment complex where rents are $1,500 per month and you believe that by renovating the unit interiors, you can actually charge 1,750 per month, you need to include that in your model. As well as factor-in the timing of when that’s going to happen because that’s going to have a huge impact on your cash flows. It will lead your internal rate of return and cash-on-cash returns on the deal.
6. Next big thing is financing:
Once you have added all of the above factors into your model, you have your operating assumptions in place. You now need to move on to your financing. Most commercial real estate investments including multifamily deals are bought with some sort of debt on that property. If you are planning to put debt into the deal, including your debt in your financial modelling, it is going to be the key to accurately projecting out what your cash flows will be and what your internal returns are going to be on the deal.
So this includes things like your loan amount, loan term, amortization period, interest rate and any sort of interest only period that you might have on the deal. Also factor-in refinancing assumptions, if you think you might refinance the deal after a few years.
Last but not the least, evaluate all the aspects of the multifamily real estate underwriting deal together that you have added to your model up to this point.
In case, if you were a multi-family broker and you looked at 10 offers that you got on the same property, chances are you’d have ten different amounts that each potential buyer is willing to invest in that property. The reason for this is that every buyer has different return expectations and what they can pay for the deal is very dependent on what those return expectations are going to be. So once you have all of your assumptions in place, what you really need to do is to come up with a purchase price that’s going to give you the projected returns.
Come up with a purchase price that could be your target internal rate of return (IRR). For instance, maybe you want a 12% IRR over a five-year hold period or you want an average 8% cash-on-cash return over a 10-year period, whatever that is for you, adjust that purchase price based on those assumptions that you made in order to create a valuation that makes sense for you and a purchase price that you feel comfortable at to buy that multifamily deal.
If you like to enhance your knowledge and skills about multifamily real estate underwriting, do not hesitate to contact us. You are welcome to sign-up for the free education available through our website https://MIHMastermind.com
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