After underwriting hundreds of deals, I’ve discovered there are a few key items that have substantial impacts on your returns.

Here are 3 key items you need to verify in your underwriting model.

Financing

Leverage in real estate is using debt to increase the potential return on investment.

Real estate is a highly levered asset. Therefore, debt has huge impacts on your returns! Minor changes in your debt assumptions can greatly change the dynamics of the deal.

In your underwriting model, verify this:

1. Loan amount matches term sheet

2. Rate cap expiration is modeled correctly

3. Correct amount of capex is financed

4. Amortization matches term sheet

5. Tax & insurance escrow amounts are accounted for

6. Months of interest only is correct

Related: 3 Critical Items on Every Lender Term Sheet

Projected Rents

Projected rents populate your income income numbers and have a direct impact on your net operating income.

We all know that NOI is the driving factor to determine value in commercial real estate.

Look at this example:

All else equal, by lowering projected rents by only $100, you can see how dramatically returns can change.

Rents are critical to get right in your underwriting model. To make sure you get this right, do this:

1. Confirm you projected rents with a local property management company.

2. Compare your rents to properties with similar vintage, amenities, and nearby to subject.

3. Verify market rents with market reports and third party data sources.

Organic Rent Growth

This is the manual input in your underwriting model that reflects the percentage increase your rents will grow each year. Organic rent growth is the expected rent increase you will receive to keep up with inflation.

Unusually high organic rent growth inputs can be dangerous because it has a compounding effect. Meaning, every year builds off of the previous.

This can make or break a deal on paper. Sponsors sometimes use this to juice the returns in their underwriting model.

There is no correct answer of what to use as it is highly dependent on the market and your assumptions on the future projected growth of the area.

However, I’ve seen most underwriters stick to 2% to 4% annual organic growth.

Related: Why Organic Rent Growth is Dangerous

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📈 Chart of The Week

Apartment Demand Finally Matching Up with Job and Income Growth

New lease traffic has been strong, indicating renters are shopping around as record volumes of supply have expanded their options. Thus, rent growth is faltering as supply does what it’s supposed to do – slow down intense price increases.

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Areas of expertise:

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• Debt & Financing Structures

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