Updated · Part of the CRE investment glossary
What underwriters check
An underwriting is only as good as the inputs it verifies. In multifamily the usual checklist is:
- Rent roll: units, occupancy, in-place rents, lease dates, concessions and delinquency. Tie it to the T-12 so the rents listed are rents collected.
- T-12: twelve months of actual income and expenses, normalized for one-time items.
- Market rents: comps for similar units in the submarket. The gap to in-place rent drives any rent-growth story.
- Expenses: taxes reassessed at your price where that applies, an insurance quote, a third-party management fee, payroll, utilities, repairs and reserves.
- Capex: the renovation budget, its timing and the rent premium it is meant to earn.
- Debt: loan amount, rate, amortization or interest-only period, and the lender’s DSCR and loan-to-value limits.
- Exit: the sale year, NOI at sale, the exit cap rate and selling costs.
- Sensitivity: what returns do when rents, vacancy, rates or the exit cap move against you.
The core math
Most of an underwriting reduces to a few relationships. Value comes from NOI and a cap rate, the loan is limited by DSCR, and returns come from cash flow plus sale proceeds.
NOI = gross potential rent − vacancy and credit loss + other income − operating expenses
- Value = NOI ÷ cap rate.
- DSCR = NOI ÷ annual debt service.
- Cash-on-cash = annual cash flow after debt service ÷ equity invested.
Worked example: year one
A fictional 40-unit property is offered at $6,000,000. The buyer underwrites a 65% loan ($3,900,000) at 6.0% interest-only and $150,000 of closing costs, so equity is $2,250,000.
The result: a 5.5% going-in cap rate ($330,000 ÷ $6,000,000), a DSCR of 1.41x ($330,000 ÷ $234,000) and 4.3% cash-on-cash ($96,000 ÷ $2,250,000). Interest-only debt flatters the ratios: on a 30-year amortizing loan at the same rate, debt service is about $280,600 and DSCR about 1.18x, below many lenders’ minimums.
| Line | Amount | How it was tested |
|---|---|---|
| Gross potential rent (40 × $1,250 × 12) | $600,000 | Rent roll, tied to T-12 collections |
| Vacancy and credit loss (7%) | −$42,000 | T-12 history and the submarket |
| Other income | $24,000 | Fees actually collected in the T-12 |
| Effective gross income | $582,000 | |
| Operating expenses | −$252,000 | T-12, reassessed taxes, insurance quote |
| NOI | $330,000 | |
| Debt service (6.0% on $3,900,000) | −$234,000 | Lender term sheet |
| Cash flow after debt service | $96,000 |
Sensitivity: the exit cap rate
Assume NOI grows 3% a year to $371,418 in year five and the property is sold then, with 2% selling costs and the $3,900,000 loan repaid. Cash flow over the five years totals about $582,000. Now change only the exit cap rate.
Half a point of exit cap moves the equity multiple by roughly 0.2x to 0.25x, and at 6.5% the investors barely get their money back. That is why underwriters set the exit cap above the going-in cap and show a range, not one number.
| Exit cap rate | Sale price | Equity at sale | Equity multiple |
|---|---|---|---|
| 5.5% | $6,753,000 | $2,718,000 | 1.47x |
| 6.0% | $6,190,000 | $2,166,000 | 1.22x |
| 6.5% | $5,714,000 | $1,700,000 | 1.01x |
What to watch for
Underwriting mistakes tend to make a deal look better than it is:
- Renovated rents applied to units before they are renovated and re-leased.
- The seller’s taxes and insurance carried forward unchanged.
- Vacancy below the T-12 and the submarket with no reason given.
- Expense growth set lower than rent growth for the whole hold.
- A broker’s pro forma from the offering memorandum treated as actual results.
- Returns shown for one scenario only.
General information, not legal, tax or investment advice. Your operating agreement, offering documents, counsel and CPA govern your deal.