Underwriting is often thought to be much more complex, arduous, or confusing than it actually is. In reality, underwriting for multifamily loans can be a simple, step-by-step process of evaluating the expenses and profits that you currently have and will have in the future. This can be broken down into several stages for the sake of simplicity and ease, allowing you to complete the underwriting process at a manageable pace and avoid getting confused along the way. With this guide, we hope to shed some light on the most important parts of multifamily loan underwriting and provide beginners with a broad look into this essential process.
Ideally, the multifamily loan underwriting process should be completed in order, but you often discover pieces you may have missed at earlier stages later down the line. The most important thing is to keep yourself on track and stay organized.
The first (and arguably most fundamental) phase of the multifamily loan underwriting process involves getting intimately acquainted with the money coming in and going out of your property. You’ll need to take a thorough and comprehensive look at your records to accurately project your post-loan costs and cash flows.
First thing’s first: we need to get to the bottom of your current and anticipated costs. This requires a high degree of foresight, as you’ll want to account for your expenses for the expected duration of your ownership of the property. To begin, you will need to carefully comb through the past year of expenses to create an accurate picture of your expected cash outflows for the next year of ownership.
There are a wide range of expenses you may not often think about that nevertheless must be included in your financial planning. This includes both routine and rare (but predictable) costs of maintaining units, services, and amenities, as well as unexpected costs that can arise while properties are unoccupied. You’ll also need to stay on top of recurring expenses such as taxes, utilities, and insurance. Assessing your insurance costs is a great time to reevaluate whether or not your coverage is comprehensive enough.
Take the time to dig deep on this one; it’s best to include everything. Don’t be afraid to confront the expenses that trouble you.
Now for the good stuff: assessing your revenue and other profits from the property. To assess the many potential sources of income associated with a property, it’s recommended to start with a thorough look at your rent roll. How much are each of your tenants paying in rent and other fees, such as pet rent, covered parking, garages, storage spaces, or any other amenities you provide? With these other potential sources of revenue from the property, do you feel comfortable with the current base rent rate? This is a great time to evaluate many aspects of your property and management style.
As in the previous step, set aside ample time to think of all the profits you bring in. If you hope to accurately project your returns, make sure to account for all the possible sources of income you have. Even vending machines can earn a steady profit!
We enter now into the realm of educated guesses and calculated predictions. There are several factors you need to account for in your financial model that are not as concrete or clear-cut as rent rates and parking fees.
If you don’t have enough cash on-hand to buy a multifamily property outright, don’t worry – you’re not alone. The vast majority of multifamily property investments (and commercial real estate investments in general) are purchased by taking on debt. If you’re financing a CRE property deal with debt, incorporating that debt into your financial modeling will be critical to correctly estimating your revenue and expected returns on the deal.
This stage requires some careful calculations. The loan amount, interest rate, amortization term, and any interest-only terms should all be factored into your planning. You should also account for any potential refinancing you expect over the next several years. This stage is your chance to prepare in advance and ensure that the financing process goes as smoothly as possible.
After digging through a blinding-white mountain of bills, statements, and other records. This stage gives you a chance to pause, take a step back, and look at everything you’ve gathered from a new perspective. The final stage of the process involves performing a final review and reevaluation of every feature of the underwriting deal you’ve included thus far. Is there any element you left out at any stage of the process? With all of your projections made, how do you feel about the terms of the deal? It’s important to be honest with yourself and confront any concerns you may have at this stage.
When you’ve completed your projections, the next step is to set a price for the property that aligns with those estimates. The price should correspond to your desired internal rate of return. It is sometimes necessary to adjust a price based on assumed rates of growth or return over the intended hold period, so make your calculations carefully: this may be one of the most important stages of the multifamily loan underwriting process.
Multifamily brokers often receive multiple offers for the same property, and among those offers, they often find a wide range of sums. This usually boils down to a difference in expectations, assumptions, and confidence that informs an investor’s willingness to pay.
The prospect of underwriting can be intimidating, but as we hope to have shown, the actual stages of the process are much more understandable and manageable than you may have heard. Though gathering all the information you need can seem a monumental task at first, exercising patience and diligence at each stage of the process will only serve to benefit you in the long run. Taking care to gather all the information you need to make accurate projections and form sound conclusions will help to ensure that your multifamily loan underwriting process goes over smoothly and results in strong returns.
With a basic level of organizational and mathematical skills, almost anyone can make it through this process. If you follow these six simple steps, you’re sure to enjoy an efficient and successful underwriting experience.
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