What are the Top Underwriting Mistakes Beginners Overlook??

[Danielle Allen]

I'm looking to compare qualitative data on underwriting mistakes and their impacts on financial forecasting. 

Any folks with underwriting/mentoring experience, what would you classify a "mistake" as? 

Do you have a margin of error that you consider rule of thumb? 

Which categories of the underwriting process do you feel has the highest financial impact of when there is a mistake? (Underestimating CapEx? Taxes? Utilities?)

Lastly, how do you communicate those discrepancies to investors? 

[Ken P.]

There are a number of expense categories that can trip up a multifamily investor during underwriting. To name a few:

- Taking proforma or even rent actual numbers at face value. If you know you need a certain quality of tenant to achieve the rental income, make sure the stats of the current tenant base meet the minimum criteria expected; e.g., rent to income ratio, credit score, bankruptcy history, etc.  "Pump and dump" by pumping up occupancy with substandard tenants is not unknown.

- Maintenance.  "Everything is updated, that's why our maintenance numbers are so low."  Go with industry standard numbers, not the numbers the seller provides.

- Personnel costs.  See above. Use industry standard numbers for the market as provided by 3rd party property management companies, not the numbers from current ownership.

- CapEx. Walk the property with your preferred contractor when getting it under contract. During due diligence, inspect every system and every single unit.

Who is the audience for your underwriting, it's not clear from the question.

[Drew Sygit]

Underestimating lost income due to vacancies and nonperforming tenants.

Underestimating maintenance expenses.

Over-estimating future rent increases when we're heading into turbulent times.

[Percy N.]

This topic could be an entire chapter if not a book by itself.

A lot will depend on the size of the asset (20 doors or 200 doors?) and the market.

- Use market-specific metrics (especially for taxes, insurance, etc)

- Your taxes are likely going to be much higher if the seller has held the property for a while and the value has increased significantly

- Use a realistic exit caprate (and ideally increment it by at least 20 bps for each year you plan to hold - again, market dependent)

- What concessions are offered in the off-season?

- What is the rent growth?

- What is the loss to lease?

- What is the delinquency?

- What is the expected a expense ratio?

- Is the property properly staffed? What will payroll be?

- Will rebranding need a larger marketing budget?

- Internal and external capex budgets

- Cost of goods (especially with supply chain issues)

- Are you planning to use new property mgt software or other tools?

- Debt service (especially with rising interest rates)

- Partnership expenses (tax preparation, attorneys, etc)

- Resident engagement programs

- Misc (travel, etc)

[Scott Mac]

I don't see how "Mistakes" in underwriting can be made by anyone who has the the appropriate knowledge of underwriting and has a checklist.

You asked for the top beginner mistakes, maybe the question should be what mistakes have you made as a beginner.

No one person is going to know what you ask, all they can do is guess at it.

You would have to talk to someone who trains underwriters in a one on one method to know that info.

And as I said before, I don't see how anyone with a checklist cold make a mistake.

Underwriters should not be making mistakes.

Underwriting is financial modeling.

I think the data you will get from your questions will simply be guesses.

It might be easier to pick another topic for our article or whatever you're going to use this for.

Such as what did you find hardest when learning underwriting.

That way your data source will be able to provide accurate answers.

Just my 2 cents

[Timothy VanWingerden]

major items that would vastly change the value of the property with improper underwriting:

1) not accounting for tax adjustment after sale. Each state handles tax adjustments differently so be aware of how it works in the state you are looking at. 

2) pulling in bad rent comps and basing rent increases on those comps. A new construction deal getting $2,000+ in rents does not compare to your "newly renoveted" 1970 property across town. Know the area well, and understand where the value capture is. 

3) capital markets - not having a good understanding of the terms you can get in the current market and getting a deal under contract only to have to retrade because your debt service is way "higher than you expected". 

[Eliott Elias]

Too optimistic on ARV