Quick and dirty rule for underwriting?

Question

Hello everyone,

I am currently educating myself on underwriting small sized (sub 10 unit) multifamily deals to sharpen my skills. Usually I am going through MLS portals (ugh) or loopnet (boo!) to find buildings for sell so I can crunch numbers. But not wanting to crunch numbers on the obviously horrible properties I am looking for a quick rule of thumb people use to get past most of the garbage on these sites.

I was originally using 10% for Capex, repairs, 10% PM, 10% Vacancy rate, and 10% profit. I would then roll Insurance, P&I, and Taxes into the broad category of Mortgage and have that as part of the other 60%.

I know there are other expenses like, water/gas/sewer/electric, Garbage but usually you cannot get these numbers from public websites and you need to reach out to the broker/owner to get these.

My question is what other expenses do you look for to factor into your calculations?

Also I picked up on the 50% rule (recently), is that what most people go by before jumping too deep into underwriting and how useful have you found it? Do you feel like you are missing out on some decent properties with it you wish you had picked up or are you comfortable with how accurate it has been?

Scott Skinger · Answer

For myself, I've come to realize that "rules of thumb" aren't very helpful in analyzing a deal and probably do more harm than good in that they will basically eliminate any deal right now and keep you from taking action. How many people do you hear say "There are no deals to be had right now, this market sucks", or some variant?  Maybe in a buyer's market where the opportunities are plenty you can use rules of thumb to eliminate deals but I think in the current market you have to be willing to dig deep to be successful.

The actions I take:

-stay focused on deals that fit my investment criteria, 10 to 100 units for me in my target market, don't chase shiny objects-scour the MLS, Loopnet & Crexi for deals that match my criteria-go to conferences, networking events and meet people from BP-meet bankers, brokers PM and investors for lunch and coffee-repeat

Basically, this is all about forming relationships and taking actions. That "crap" deal on Loopnet might actually be a good deal if you call/email the broker and find out that the seller is really motivated and will sell for $x less or the seller has 7 other buildings for sale not listed. Both happened to me recently.

Regarding what I look for though, if you want to call it rules of thumb:

1. Must fit my criteria above. Good street/neighborhood? Good unit mix? Good size units? Any sort of "weirdness" about the building/area?

2. Gross Rents. As @Robert Meyer pointed out, I also look for gross income, not just current gross income but the potential gross income. You need to know your market well to know what rents you can get taking into consideration unit size, condition, etc. Maybe the deal is a good deal if you know you can get higher rents.

3. Expenses. Brokers are liars, sellers are liars...or maybe you call them marketing experts. If you base your expenses off of the listing, OM or even exclusively off of their actuals you will be in trouble.

You need to know expenses in your market and it is super helpful if you know what your expense cost/unit is. The more you know your market, talk to brokers, talk to PMs, talk to other investors the better you're going to be at underwriting.

Robert Meyer · Answer

2% rule is my go-to.  Look at gross monthly rents over asking price.  If it's greater than 1.25, I might take a closer look based on other info, if it's over 1.5% I definitely dig in deeper.  2% is tough to come by anymore, and usually comes packaged with other headaches.  Based on the area, if you buy at 1.5% you're likely going to cash flow.  Knowing your market helps, so you can see if rents are at market and if you can reduce expenses. Be careful automatically assuming 10% for CapEx, repairs, etc.  This may price you out of certain opportunities that might be worth a shot.  Knowing your market, again, is key.  Talk to local agents, investors, and prop managers to see what they use for those % assumptions.

Don't be too quick to say you can't estimate water/gas/etc. If you analyze 20-50 properties in a certain market you'll start to see a trend in expenses per unit.  It won't be perfect, but will get you in the ballpark of what is a reasonable expense based on the size of the building.

50% rule is a swag...some building run leaner than others.  It might get you in the ballpark, but I wouldn't rely on it solely on whether to investigate a property further, but rather to supplement other indicators.

I grew up on Fort Collins, so say hi to CO for me.  You're in a tough market, best of luck!

Rob