Skip to main content
Financial Analysis

Underwriting 101

By June 11, 2019June 25th, 2019No Comments

This it the first of a 3-part series on underwriting and will answer the following questions:

What is it?

Why is it important?

How do we underwrite a property?

Underwriting is a fancy term for financial analysis. It’s the “nitty-gritty” of real estate and an integral part of every investment.

Being able to underwrite a prospective acquisition is a skill that takes time and experience. It’s often tedious but it’s where you can uncover hidden value in a property.

When a new property comes to market, most often an investment sales broker will send out a listing package. This will include an offering memorandum or property brochure that explains the opportunity and provides the basic information including the property’s location, physical characteristics including number of units or rentable square footage, equipment information such as type of HVAC system and construction type and financial information including income and expenses.

Listing packages will also include a current rent roll which is a list of all tenants at the property, the space they occupy, their current rent charges and any other pertinent information to their tenancy including reimbursements they pay to current ownership, free rent concessions, lease expiration dates, etc.

In addition to the rent roll, a listing package will include the profit and loss reports for the prior 12 months, otherwise known as a T12. This will break down all income collected from the property as well as all expenses paid.

Before you consider purchasing a property, it’s imperative that you determine the current income and expenses to see if they’re realistic. Assuming you have experience in a certain market and product type, you’ll probably have an idea of what the major expense items will cost on a per unit or per square foot basis and you can compare them to the reported numbers from the broker.

But let’s assume you’re considering a new market for the first time and have no idea about typical operating expenses and you’re trying to analyze a prospective acquisition.

A good resource would be a local property management company. You can find a good management company by looking at IREM.org, or by asking your broker for some recommendations.

Speaking to at least 3 management companies and asking them about typical operating expenses in the properties they manage is a good start and will give you a decent basis for comparison.

In addition, when researching a new market we recommend taking a look at every deal that’s currently for sale.

By reviewing the financial statements for properties that are similar to your prospective acquisition, you’ll start to see some patterns appear. You may see that insurance costs range between $400-$500 per unit per year while repairs and maintenance costs range between $625-$750. At this point you should create your own spreadsheet of typical expenses that you can use as a guideline when analyzing deals in the future.

After you determine the typical operating expenses for a property, compare them to the reported numbers from the broker.

If an expense is within 10% of your expected numbers then you can be confident that you’re seeing realistic numbers and the Net Operating Income is probably close to what the broker is representing. (For a refresher on NOI, please click here for a quick refresher.)

If the numbers are more than 10% off the typical numbers, you should highlight these numbers and ask your broker for additional verification. For example, if the water bill is significantly lower than you expected, ask to see the last 12 months of water bills.

Once you have reviewed the operating expense numbers, take a look at the rent roll.

You want to understand what the average rents are, the concessions offered, the unit types (1 Bed, 2 Bed, 3 Bed, etc.) and the vacancy rate at the property and compare that to the market. Are the rents low compared to similar properties in the area? Is occupancy much lower than comparable properties?

You can determine market rents and occupancy by conducting a rent survey. Just call up 3-5 properties in the surrounding area and see what asking rents are for each unit type.

You can also ask your broker for research reports from CoStar and Yardi Matrix which will provide detailed breakdowns of market occupancy, average rental rates, rent trends and recent sales.

Once you’ve determined what the market rents are, compare them to the rent roll. Are they dramatically higher or lower? If so, you should ask your broker for an explanation.

It’s possible that rents are lower because the units haven’t been renovated, creating an opportunity for you to upgrade the apartments and increase income. Perhaps rents are higher than the surrounding area because the property is in superior condition or in the best part of town.

Either way, you should compare the results from your market survey to the rent roll and see if there are opportunities to grow income.

Let’s stop and review. So far we have:

-Determined the typical operating expenses in a given market by reviewing the financial statements of comparable properties and calling property management companies

-Determined market rents for the property by conducting a rent survey of comparable properties in the area

-Reviewed the Trailing 12 Months of financial statements and highlighted any glaring discrepancies

-Analyzed the rent roll to see concessions, lease expiration schedules, average rents and occupancy

At this point, we’re ready to begin underwriting the acquisition as we have all the raw data we need.

Next week’s post will get into the specifics of how to analyze a property using this information to figure out what sort of returns you can expect to generate and the price you should pay.

If you have any questions or would like to speak to us regarding our underwriting process and the opportunities we’re currently working on, please call us at 212-426-2641 or email us at JB@wynmanage.com. You can also reach out through our website at www.WynManage.com.