Three lessons from underwriting over 150+ multifamily deals
Three lessons from underwriting over 150+ deals on a public REIT's multifamily acquisitions team, and now for clients.
Underwriting is not just filling out a spreadsheet. It is modeling how you think a multifamily property will actually perform. The assumptions that break are rarely the ones nobody checked. They are the ones everybody accepted because the sponsor supplied them. These three lessons are about sourcing, substituting and timing the work.
What makes an underwriting assumption defensible?
An assumption is defensible when you can name where the number came from and show that source to someone who did not build the model. Your committee or your investors are putting their own money, or the firm's, behind the deal. When the question comes, "why are we using that assumption?", "because the sponsor said so" is never the answer. You build a case, even when the case runs against the sponsor.
Here is what that looks like. On a new construction deal for a client, one of the biggest drivers was construction cost. The budget came from a reputable firm and we could get comfortable with it. Where we disagreed was contingency and escalation. Contingency covers unexpected changes to the build. Escalation accounts for inflation between the day the budget is priced and the day the building actually goes up.
That budget carried the builder's 3 percent contingency with the sponsor's 2 percent cushion on top. Five percent sounds reasonable. But there was no escalation line anywhere in the budget. When I raised it with the sponsor, we talked through inflation and confirmed it had not been carried into the underwriting at all. The gap was not the sponsor's cushion. It was the missing escalation.
I cannot underwrite a number I cannot defend, so I went looking for independent sources I could put in front of my client. One was not enough. Seven published construction cost indexes later, the picture was clear, and I had a case I could defend in front of my client, the sponsor, or whoever else asked.
Construction cost is not the only place this happens. Here is where I have seen aggressive underwriting on deals that came across my desk.
| What gets optimistic | Sponsor assumption | What I check it against |
|---|---|---|
| Rent growth | 3 to 5 percent a year, every year of the hold | 3 to 12 month rent trends, population growth, and the new supply pipeline |
| Cap rates | Tight to the market | Recent sales in the surrounding area |
| Insurance | The T12 number, carried forward | An updated quote |
| Taxes | The seller's tax bill, carried forward | The county reassessment schedule, and similar properties sold in the past 3 to 5 years, far enough back that a post-sale reassessment has shown up |
A defensible underwrite is not the most conservative one. It is the one where every number has a source you are confident presenting to the people funding your deal.
What do you do when the data you need isn't there yet?
You stop waiting on the source you wanted and build the case out of what you can already reach. I was underwriting a multifamily preferred equity opportunity in Arkansas, and the concern was new supply and what it would do to income at the property. I asked the sponsor for updated diligence on how the asset was performing, and they took their time.
Deals do not pause while you wait. So instead of waiting, I indexed market performance against the timing of new deliveries in that submarket. It was not the source I thought of first. It was a source I could reach right away, and it answered the same underlying question: how does this submarket perform under new supply pressure? When the sponsor's numbers did arrive, I was better prepared to see how they fit.
Data in commercial real estate is scarce, inconsistent and rarely current. When you are stuck waiting on an analysis, take a step back, find the driver underneath it, and go find the sources that build the case you need.
How fast do CRE deals actually move?
CRE deals move slower than the pressure on you suggests. On a live deal everyone wants answers yesterday. I have worked until 4am, and on weekends, including once on my birthday. The thing is, once you are done sprinting, you wait. The broker needs to digest it. The sponsor waits on improved financials. The market moves and the business plan moves with it.
You do the work up front because you have to be ready to run. Then most of the time you spend a while walking. That is not wasted, as long as you understand what the sprint bought you: not a finish line, readiness. AI shortens the sprint. It does not speed up a committee deciding how to put investor or firm capital to work. What it buys you is being ready the moment everyone else is.
If you need underwriting backed by data you can actually point at, on a timeline that fits the deal, that is what the underwrite is for. Reach out and I will help you get to a number you can defend in front of committee.