Understanding The Underwriting Process
When it comes to multifamily investing, we pride ourselves on being the facts and fgures guru’s as we have gone through the underwriting process 100+ times. For you as a passive investor understanding the underwriting process to some degree is vital to deciding if a deal is right for you. Understanding key aspects line the NOI, CAPEX, and Vacancy to name a few. This process can seem daunting, and may take some practice but it’s important to remember that it’s in place to protect both investors and borrowers.
Here we’ll break down some basics around underwriting so you can understand what to expect during your next investment transaction.
Here we’ll break down the basics of underwriting so you can understand what to expect during your next investment transaction.
Before a multifamily investment property is bought or refnanced, the potential lender will require an analysis of the property’s revenue and expenses. The purpose of this analysis is to understand the fnancial performance of the property and to ensure that the loan amount being requested is supported by the property’s income.
This analysis is typically completed by a professional frm specializing in real estate investments, and is generally known as an “in-place revenue study.”
An in-place revenue study will analyze past fnancial performance, as well as current and projected revenues and expenses. Based on this information, a conclusion section will be prepared that summarizes the fndings of the study.
This information is then used by the lender to decide on whether or not to provide fnancing for the multifamily investment property.
When underwriting a multifamily investment, one of the most important factors to consider is the property’s in-place expenses. This includes both the operating expenses (such as property taxes and utilities) and the capital expenses (such as major repairs and renovations).
By understanding the in-place expenses, underwriters will get a clear picture of how much it will cost to operate the property every month. Additionally, this information can be used to negotiate more favorable terms with the seller.
Furthermore, by understanding the in-place expenses, underwriters can develop more accurate pro forma projections for the property.
Are you familiar with a pro forma? Here is a quick breakdown of what it is and how it works…..
For us here at Falcon we do not typically go for new construction as a part of our strategy however we wanted to share with you what this portion of the underwriting could look like.
The construction budget is one of the most important aspects of the underwriting process for multifamily investments. This is because the construction budget will determine the amount of money that can be spent on the project, as well as the schedule for completing the project.
The construction budget must be carefully prepared to ensure that the project stays on track and budget. Several factors must be taken into account when preparing a construction budget, including the cost of materials, labor, and permits.
In addition, the construction budget must also factor in any unexpected delays or cost overruns to name a few.
Growth and Vacancy Assessment
The underwriting process for multifamily investments usually starts with growth and vacancy assessments. This assessment is important to determine whether the rental market in the area is growing or shrinking.
If the market is shrinking, then it is likely that there will be fewer renters looking for apartments, and vacancy rates will increase. As a result, it will be more difcult to fnd tenants for the units, and the property may have to lower rent rates to attract renters.
On the other hand, if the market is growing, then there will be more renters looking for apartments, and vacancy rates will decrease. This means that the property will have an easier time fnding tenants for your units and can charge higher rent rates.
Projecting Rate Increases
Based on the growth and assessment analysis, an underwriter can then determine if there is enough growth to justify a rate increase.
In any investment, increasing existing revenue through rate increases is a solid strategy. By raising rent rate by a small percentage each year for new and existing tenants can have a dramatic impact on top and bottom-line revenue.
However, raising rent too high can hurt occupancy rates and can be difcult to reduce. Therefore the rate increase will be assessed by similar properties nearby and calculated competitively.
Taking on Debt
When it comes to multifamily investments, it’s important to understand the underwriting process – specifcally when it comes to taking on debt.
The frst step is to determine the loan-to-value (LTV) ratio, which is the amount of debt the investment is willing to take on relative to the value of the property.
Once the underwriter has calculated the LTV, they will need to get approval from the lender to provide the investment with the capital to fund a loan that refects that ratio. To do this, they will need to provide a detailed business plan that outlines the investment strategy and demonstrates its ability to make monthly payments.
Creating a Valuation
Internal Rate of Return (IRR) and Equity Multiple are the two primary metrics that investors use to evaluate multifamily investments. Both measures take into account the cash fows associated with an investment over its lifetime.
However, IRR gives greater weight to the terminal value, while Equity Multiple focuses on current cash fow. As a result, IRR is generally more relevant for investors with a long-term horizon, while Equity Multiple is more appropriate for those looking for immediate returns.
Cash-on-Cash is another metric that is sometimes used to evaluate multifamily investments. However, it is less informative than IRR or Equity Multiple because it does not take into account the time value of money.
If you are interested in multifamily investments, it’s important to understand the underwriting process. This will give you a better idea of what to expect and how to prepare yourself and your project.
At Falcon Capital, we have a lot of experience helping investors just like you get started in this exciting market.