Can someone explain underwriting in detail?

Question

What exactly is underwriting? What is the purpose of having an underwriter? Is it something you have to have when purchasing a property and why?

Alexander Felice · Answer

Underwriting is how you measure, mitigate, and spread the risk of an investment.

For a real estate investor this means understanding what expenses and risks the property will have and addressing each and every one of them. The more risk you can account for and spread, the more stable your asset will perform.

On BP the term underwriting is mostly synonymous with "making sure your numbers are right" which for SFR and small multifamily is a fairly satisfactory explanation. As deals become more complicated the risk mitigation plans do as well.

Underwriting will be different depending on the business, for instance how and insurance underwriter mitigates risk will be different than residential multifamily will be different from commercial retail, etc but essentially everyone is doing the same thing: moving and limiting risk.

Mitch Provost · Answer

Account Closed nailed it. Just remember that risk is a measure of uncertainty. The less we know about something, the more risk there is. The best way to manage risk is knowledge (research, due diligence, experience).

Also, risk is a personal (or company policy) thing. Different (underwriting) results can be calculated based on your tolerance for risk. For example, Fannie Mae has a specific risk tolerance that is used in their underwriting.

Many people I see on BP are very risk-averse and their offers for a property will never be accepted. Others have a higher tolerance for risk because of their knowledge and can be more aggressive with offers, thus have more success. However, they must work harder/smarter to ensure their identified risks don't actually happen or the impact is minimized.

Mitch Provost · Answer

Account Closed, the risk you identified is that something could go wrong with the plumbing or electricity since they haven't been updated. You should first have the plumbing/electricity inspected (either by you if you know what you are looking at or a professional). With that information, you can estimate how much it would cost to make any repairs if they become needed.

With these costs, you can decide how best to mitigate. It could be to improve the installation now to prevent future repairs, add additional money into your ongoing or future expenses (for potential repairs), or do nothing. What you do depends on your own tolerance of risk.

Account Closed · Answer

@Mitch Provost thank you for the help Mitch! Very much appreciated!

Account Closed · Answer

@Mitch Provost thank you for the follow up Mitch! Just a follow up question to mitigating the risk of an investment. Are there certain check points a rehab property has to pass in order for you to invest in it? For example if everything looks good but the plumbing or electricity haven’t been updated, is that something that’s such a great expense that you’d rather stay away from?

Account Closed · Answer

@Alexander Felice very much appreciated the detail of your post!

Can someone explain underwriting in detail?

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