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The affordability test is something all multifamily underwriters should be doing when modeling a potential acquisition.

This simple, yet extremely valuable test you can use to evaluate if the potential tenants in a given submarket can afford the rents you are projecting by using the household income.

We need 2 things for this:

Median Household Income (I like using 1-Mile radius)

Pro Forma Rents

Average Household Income Defined:

The term household (HH) income generally refers to the combined gross income of all members of a household above a specified age. Household income includes every member of a family who lives under the same roof, including spouses and their dependents. The incomes of everyone count even if they aren't all used to support the household.

The Affordability Test:

Most property managers require a 3x Rent-to-Income Ratio. Meaning, the tenant has to earn at least 3 times their monthly rent amount. A 3x is just a rule of thumb we will use today.

We can calculate the Rent-to-Income Ratio like this:

1-Mile Median HH Income / (AVG Rent x 12)

I'm taking the Median HH Income and dividing it by the annual average rent.

 Example:

In this area, the 1-Mile Median HH Income is $45,000. Our company will only rent to tenants that have a rent-to-income ratio of 3x.

The average in-place rent at this property is $1,000/month. Potential tenants can easily afford $1,000/month because the rent-to-income ratio is 3.8x. The household in this area makes 3.8 times the rent amount.

If I were to underwrite to an average pro forma rent of $1,400, this could be a serious problem. The rent-to-income ratio drops to 2.7x, lower than our requirement of 3.0x.

If the median HH income is $45,000 and we have a 3x rent-to-income requirement, the max rent we could potentially charge is $1,238/month.

Download this affordability test for free here!

👋 Do you have an active deal and need the best possible financing terms? Reach out to Larry Wilemon with Walker & Dunlop. Our team has transacted with Larry several times and we highly recommend his services!

Larry Wilemon, [email protected]

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