WS277: Underwriting with Brian Burke

RES 277 | Underwriting Properties

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The thing about underwriting is people always want to find an easy way to do it. Brian Burke, the President and CEO of Praxis Capital Inc., says that is not how it works. Brian joins us to guide us through the steps of doing it right, sharing the three important things in the process. As he dives into some of the things he has learned over the years about underwriting, he also shares some of the problems he encountered and how he kept them from happening again. Breaking down the numbers, Brian shows how he calculates the rent charges and other overlooked expenses other than taxes that people often miss. He also tackles bad debt and loss to lease, and introduces an underwriting tool called Real Data.

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Underwriting with Brian Burke

Our guest has been on a couple other times. You’re going to remember his name and he was on episode WS23 and on WS247, which I highly encourage you to go back and read. I want to tell you he will cross over $500 billion in real estate that you’ve acquired. Is that correct?

Yes. It’s almost weird even to say that.

It’s Brian Burke. Thanks for being on the show again, Brian.

Thanks for having me, Whitney. It’s always a pleasure to be here. We have a lot of fun.

I’m always honored to have you on. Obviously, that acquiring that much in real estate, you have tons of experience and I love having you on and the audience always learns a lot from you. You’re the President and CEO of Praxis Capital Inc. I want to make sure the audience knows that. They probably remember it. I want us to jump into the topic of underwriting, and as we dive in a little deeper, how you all underwrite and maybe some things you’ve learned over the years. Maybe some problems you’ve encountered and how you keep those problems from happening maybe that you didn’t know when you started or years past. Get us started a little bit on some common things about underwriting and things we should know.

The thing about underwriting is people always want to find an easy way to do it. There’s always those who will say, “I want to do a back of the napkin approach. I want to use a rule of thumb or I want to be able to screen a deal in 60 seconds or less and know if it’s any good.” It doesn’t work. I’m here to tell you none of that stuff works. I’ll give you my three-second underwriting tests. This is how I can tell if a deal needs to go in the delete bin or investigate further in three seconds. I basically will look at how many units, where is it and what year it was built. If it’s too old, it’s in the delete bin. If it’s too small, it’s in the delete bin. If it’s in a city that I’m not interested in investing in, it’s in the delete bin. If it survives that three-second pass, the next step takes hours. You can’t say, “I’m going to apply a rule of thumb or I’m going to use a 2% rule or a 50% rule.” None of it happens. You’ve got to start from the beginning and walk through it step by step. That’s how it’s done and it’s the only way it’s done.

Tell us those three things and then tell us what they are for you.

My three things: how many units, what year it was built and what city is it located in. Your three could be different. Maybe you don’t care where it’s located or maybe you don’t care how big, small, how old or how new it is. For me, I have a very predefined box. I’m basically buying stuff that’s built between 1980 and 2009. Anywhere between 100 and 1,000 units and located in a specific set of markets that interest me in mostly located in the Southeastern and Southwestern US, Arizona to Florida and a lot of stuff in between. If it’s in Indianapolis, I’m probably going to delete it. If it’s in Montana, I’m probably going to delete it. If it’s 55 units, I’m going to delete it. If it’s built-in 1965, I’m going to delete it. If it was built in 1975, I’m going to think about it. We’ll occasionally dip into 1970s product in the case by case basis. If it fails any one of those tests, it’s out of here. Exercise of financial engineering and financial fact-finding to walk all the way through to know if it’s a good deal or not.

Brian, I have a smoking deal on Billings, Montana.

Tell me how it works out for you.

We’ve met those three criteria. You’ve said, “I need to take that next step,” that you talked about that’s going to take hours. I’d love for us to get into your next steps to help us understand the steps that we should be taking after we get those initial three things done.

The next step is we build a model. The model is that we take the rent roll and we break down the rent roll to determine what each floor plan, we were building a 100-unit multifamily. We have what’s called a Unit Mix. A Unit Mix is a grid that will show all the different floor plans at that property. Let’s say we know there are 50 one-bedroom, one-bath units that are 780 square feet. There are 25 two-bedroom, one-bath units that are 800 square feet and 75 two-bedroom, two-bath units that are 975 square feet and so on. We break down every floor plan on this grid and we determine how much they are getting on average for each of those floor plans on their current leases. We also look to see in the last 90 days what have they been getting. People who have moved in in the last 90 days, what are they paying? That gives us a good picture of where rents are and where rents are headed. That’s step one.

[bctt tweet=”The thing about underwriting is people always want to find an easy way to do it.” username=””]

Step two is we take their trailing twelve-month financials and we put that into our model to show all their income and expenses for the last twelve months. We also take their last three months and we annualize and put that in a side by side comparison to see what is the income look like in the last three months. We can compare the income to see if it’s rising or falling recently relative to what it’s done over the last year. That’s step two. The next step is we take all that and we put it all together. Figuring out how much debt we can get on that property, putting in some debt terms and then looking to see what does a seller want for this deal? Having some idea of what their pricing expectations are. We can determine are we even close enough to bother? If we’re more than 10% or 15% off, the deal goes in the trashcan. If we’re within 10% or 15%, maybe even within 20% depending on how motivated the seller might be, then we go to the next step, which is a tour where we go to the property. We look at the property. We can go to comps. We look up the comps and then we go back and make adjustments to our model. It’s a multistep process and very hands-on.

It sounds like it but you have to get to $500 billion. We’re not talking about a $30,000 flip.

We’re talking about deals that we’re closing in. Our two are right around the $20 million mark each. When you’re talking about that money, little things move the needle a lot. When you have 300 units, $25 a rent moves the needle a lot. Accuracy is important and you can’t be sloppy in the way you underwrite. The way I look at it is we’re the real estate business. Everybody’s probably at least somewhat familiar with the process of building a house. Underwriting is a lot like building a house. Before you can start throwing walls in the air, what’s the first thing you have to do when you’re building a house like what? You’ve got to build a foundation. That foundation has to be strong or otherwise, your house is going to fall down after you’re done building it.

The foundation of underwriting is figuring out what rent you can get for the units after you’re done doing whatever it is that you’re going to do to them. That is your foundation. This is where a lot of people make a mistake and underwriting us to go, “The units are only running for $700. If I use $700 as my rent and these are my expenses, I take the 50% rule for expenses and I whack that off the $700 rent. That’s the cash that’s left. I run an IRR calculation on that and the deal is no good.” Of course, it isn’t because that’s probably not the rent you’re going to charge. You’ve got to look at what the rent comps are telling you you can get when you’re done doing whatever it is you’re going to do. This goes all the way back to my house flipping days. I’ve flipped about 700 and something houses. In doing that, the first thing I always needed to know was what is the house going to be worth when I’m done fixing it up.

That’s the very first thing because how much you can pay for that property entirely depends on what it’s going to be worth when you fix it up and how much it’s going to cost you to get there. Those two pieces are going to determine how much you can pay. Nothing is different in multifamily. It’s the same exact thing. You just back into it in a different way. In multifamily you take, “What’s the rent I can get for those units after I fixed them up? How much is it going to cost me to fix up those units?” Those are your two key components determining how much you can pay for multifamily because they set the foundation to all the rest of your underwriting. How much you earn an income is all dependent upon the rent you can receive.

Tell me how you’re finding that information, but then also how you’re verifying that with the rents that you’re projecting that you’re going to be able to charge?

RES 277 | Underwriting Properties
Underwriting Properties: Underwriting is a lot like building a house. Before you can start throwing walls in the air, you got to build a strong foundation.

What we do is when we’re touring a property, let’s say we’ve identified we want to buy Marvin Gardens. We go out to Marvin Gardens and we start walking around and we get to tour the units. We’re looking at the units and the condition that they’re in and the amenities that the property has. It’s got a swimming pool, a fitness center, a business center, all those different amenities and what’s the curb appeal look like? The next step we do is we’ll ask the management, “Who’s your chief competitor? Give me the top three properties. If somebody doesn’t lease here, why didn’t they lease here? Where did they go? Who did they lease from? Who are you losing prospects to?” We’ll visit those main competitors. We’ll also drive around the neighborhood and find other competitors that they neglected to mention. We’ll visit those competitors and we’ll do the same thing at those properties that we did at the subject property. We’ll tour a unit. We’ll look at the condition, we’ll see how upgraded they are, what amenities they have. We’ll compare the amenities, quality and condition of those units to the subject property. We’ll compare that comparable rent and the size of their unit and all that to the subject property. This is where art comes into play. That part is the science part. We decide how much we can charge based upon all that information that we gathered.

I like how you talked about you’re actually going to go there. You’re not relying on some third-party report or You’re going there, you’re meeting the people and you’re asking even them who their competitors are. You’re getting to touch the countertops and you’re getting to put hands-on and get a feel for living there. The next step you said is?

The next step is once you get all that information and you put it into your model, you’re going to make an opinion of how much you can charge for rent on your units after you’re done doing your upgrades. That’s going to give you the starting point for your income. Certainly, you don’t get there on the first day. You’ve got to ease into it and ramp it up so that you’re going from basically the income that property’s producing to the income that you’re going to get it to produce in the future, probably in two to three years. You’re going to slowly increase the income from where it is to where you think you’re taking it. Step three is you have to build your expenses out. Building your expenses out is partly looking at what the property has historically been paying for various expenses.

It’s also partly dipping into your own experience of what it costs you to run a property and it’s also partly adjusting to reality. There are a couple of different moving parts there that I mentioned. Looking at historical. It’s fair to look at historical utility bills and how much is the lawn mowing service charging to mow the lawns and all those things and assume that you’re going to be paying those same costs plus a little because everything goes up. That’s going to be what your expenses in those categories are going to be. What the property has historically paid in, let’s say property management fee has nothing to do with what you’re going to pay because your income is going to be different. You have to adjust to reality and that property management fees will be the proper percentage of your forecasted income. Your property taxes, this is a big one that a lot of people overlook. You have to adjust your property taxes for what your property taxes are going to be. In some jurisdictions, they’ll reassess the value of the property to at or near the purchase price.

That can move the property tax expense a lot. California is probably the worst example. With our Proposition 13, property taxes here, if you have an owner that’s owned it for 50 years, your property tax might be 50 to 100 times their property tax quite easily. The property tax number and the historical financials means absolutely nothing compared to the property taxes you’re going to pay. You have to research that and determine what those property taxes going to be are. You just have to adjust to your operating style. How much are you going to pay your staff? That’s going to be your payroll number. What are your ancillary costs that are going to influence your general and admin numbers? You’ve got to build out an expansion to determine what all those expenses are going to be and that’s going to refill your income.

What are some overlooked expenses other than the taxes like you mentioned? Anything else that get people in trouble that they miss?

[bctt tweet=”Exercise financial engineering and financial fact-finding and walk all the way through to know if a property is a good deal or not.” username=””]

I think taxes are probably number one. A lot of people don’t understand how property tax structures work in various jurisdictions. It’s confusing because property taxes are different from one jurisdiction to another. A lot of times, it’s very difficult to figure out what taxes are going to be, even if you do know the system. That one’s a big challenge. The second one that I would say is probably the next biggest challenge is payroll. A lot of times I’ll see, let’s say you’ve got a property that’s underperforming, it’s under-managed, that presents the opportunity. They’re paying $800 a unit per year in payroll expenses. When you’re modeling out your own expenses, you’re like, “They’re paying $800 a year for payroll, so that’s probably what payroll costs. It costs $800 per unit per year. That’s what I’m going to use.” Neglecting completely the fact that this property is underperforming and under-managed. One of the reasons it’s underperforming and under-managed because it has a substandard staff or not enough staff or the wrong staff, or an inexperienced staff or no staff at all. It’s being run by the owner’s brother-in-law and then that’s it. You have to be realistic about how much it’s going to cost you in payroll. I see that mistake made a lot where people underestimate payroll expenses.

How much do you ask your property management company and how they can operate the property? Those expenses and obviously, if they have staff and you’re paying them and they say, “We can operate it much better than this property that you’re comparing it to.” How much do you rely on what they say?

If you have an affiliation with a property management company, you’re using to manage your assets. You can lean heavily on them and I suggest that you do so. Here’s why, especially if you don’t have a lot of units of experience or you don’t have a lot of units in the area of experience. Property management firms typically do. If they’re managing a lot of properties and a lot of units, they know what the expenses look like in that area. Until you’ve gotten to the point where you have that own knowledge internally, you want to lean heavily on your property management company because they’ll tell you. You say, “How about $800 a year for payroll?” If they’re good property management that’s been around, they’re going to tell you there’s no way we should run our property at $800 a unit for your own payroll. It’s going to be $1,200 per year or $1,300 per unit per year or whatever the case may be. They’re going to be enormously helpful and helping you figure out those expenses.

In the underwriting process, I know you mentioned, where are we spending most of our time and through that process?

Most of our time comes in the market study. That market study of surveying what the comparable rents are because it moves the needle more than anything else. It’s the most important thing to get accurate. If your rent is off by $25, that could move your purchase price by $1 million on a larger property, but if you’re off $25 a unit per year in a payroll expense, that’s not going to move the needle that much.

You had mentioned you’re looking at all those other units, you see what they rent for and a big part of it is knowing you can rent these units. How close when you’re doing your underwriting, are you putting those numbers to the market rents, the ones that you actually toured?

RES 277 | Underwriting Properties
Underwriting Properties: Be conservative in your economic losses, but strive to be very accurate in your market rents.

We’re nailing it. In this competitive landscape, if you try to say, “I think we’re going to get $1,050, so let’s use $1,025. That $25 swing can move the price of $1 million. You could be way off and you might not buy anything. The place to get conservative as in using conservative vacancy factors, conservative concession losses, bad debt, loss lease. Be conservative in your economic losses, but we strive to be very accurate in our market rents. More often than not, we nail it. Sometimes we’ll try to go a little bit higher and say like, “We think we’d get $1,000. Let’s try to get $1,025 and we’ll get it.” More often we’ll just stick with $1,000 and see how that works for a while before we try to increase the rent even further. So far, knock on wood, we almost always get the rent that we’ve projected and we probably could have gotten a little bit more, so maybe we’re somewhat conservative. I wouldn’t say that we’re trying to undercut it too much.

For the readers who haven’t underwritten many properties yet, you’ve mentioned a bad debt. What is bad debt?

As much as it may come as a surprise, every once in a while, tenants won’t pay you. As shocking as that may be, pause for a moment of silence while we all get over that. No matter how hard you try, you’re not getting the money out of them. You have to write that off. In accrual accounting, you’ll mark the unit down as let’s say your rent’s $1,000. It’s due now and you say, “We collected our $1,000 rent.” If you haven’t collected it, you’re still booking it as income even though you haven’t collected it yet. It goes on your balance sheet is an accounts receivable. If the tenant doesn’t ever pay and you evict them, eventually you never got that $1,000. Eventually, that has to come off your income statement. You charge it off as bad debt. You’re writing it off. It’s a negative income item. You have your $1,000 rent for June and then in July, you have a negative $1,000 bad debt loss because you’d never got June’s rent.

It’s a number we should be paying attention to. You also mentioned the loss to lease. If you could just elaborate on that as well.

The loss to lease is the difference between the rent that you’re getting and the rent that you’ve set. Let’s say we did our market study and we determine that we can get $1,000 for that unit. We set our goal rent is $1,000. We buy the property, everybody’s paying $800. We have an automatic $200 loss to lease. The difference between the $1,000 market rent and the $800 lease rent is a loss to lease. Our job now is to compress that loss to lease, which means to reduce it by doing unit renovations and renting out units to new residents at turnover for a higher rate. We renovate five units and we rent those five units out at $1,000, but everybody else is still paying $800. Our loss to lease isn’t however many units we have times $200 anymore. It’s how many units are still paying $800 times how many units that are and that’s it because the other five tenants are paying the full $1,000 rate.

We’ve now reduced that total loss to lease number. The objective is eventually you want to get it to zero. You never will, and this is another underwriting mistake as people will write in the loss to lease for like years one, two and three while they’re increasing rents to their new market rate. After that, they set it to zero but you never get all the way there because leases don’t expire all on the same day. You’ve got leases that roll all throughout the year. You’re always going to have some residents that are paying a lower rent than others. They just haven’t gotten their increase or they’ve been there a long time and haven’t been brought to market or whatever the case may be. There’s always going to be some loss to lease leftover and you should have some factor for that in your underwriting.

[bctt tweet=”When you set expectations properly with your investors, you’re going to have happy investors.” username=””]

Is there a specific tool you use for underwriting that you can share with us or is it something that maybe you all have built over time? What does that look like for you all?

We’ve created our own. I started out with a commercial product called Real Data, which is available online. It was $500 or something at the time I bought it. It was a robust underwriting platform that I used when I first got started. I realized that the way we underwrite and the things that we’re looking for and our style, it commanded a lot of customization to get exactly what we wanted. Ultimately, I scrapped all the commercial products, just went straight for developing our own system. I’ve spent thousands of hours and that’s not an underestimation building this modeling system. I’ve been told by some heavyweights that it’s probably one of the best in the business that they’ve ever seen. You have to have something that’s robust like that because accuracy is critical when you’re in a competitive environment.

Is that something that you’ve built in Excel?

It is. It’s Excel-based.

Is that for sale?

Never. There are two reasons. One is it’s a competitive advantage and the other is that I don’t want to be in the software support business. The multifamily acquisition business is highly individualized and everybody has a little bit of a different style. Having a model that’s built to exactly your own specifications is important because it’s going to be modeling deals out the way you do deals and the way you look at things. It’s going to have all the things that you need and things you like to look at. That’s one aspect of it. The other aspect is that, in my opinion, the only way to do it is to write it yourself because you want to have 100% knowledge of every single number in your entire underwriting system, so that when an investor says, “I saw here in year four on this line, it says this. Where does that come from?” You want to be able to answer that question at the snap of a finger and not go, “I got this underwriting program and I’m not sure what it does. I put in the income over here and it spits this out.” That’s not good enough. You’re talking about other people’s money and they want to know that you know where it’s going, and the only way for you to know that is if you wrote the flow from start to finish yourself.

RES 277 | Underwriting Properties
Underwriting Properties: Properly underwrite the deals that you do see so that you can project the returns to your investors.

That is going to be probably one of the only ways you can know it in that depth. Where do we start though, for the audience that’s learning this business get started or even the passive investors reading saying, “I’m not going to learn the whole Excel spreadsheet or maybe I want to?” Where do I even start to know what needs to go into that spreadsheet or the best way you would recommend somebody to learn to underwrite?

I found a couple of websites. There are a couple of them that I’ve seen that I think are pretty good. One of them is called They’ve got a bunch of different models and models for sale. Another one is REFM and I think their website is They have different models for sale. Whether you use them or not, when you go through those models, if you purchase them and at least look at the different things that they do, it will give you ideas on different things that you can do. I did mine basically by just one piece at a time figuring out, “I needed to do this.” You see different underwriting examples in various places and you’re like, “I needed to do that.” Literally, that’s why I say it took thousands of hours to design it, but you could at least get a good idea by looking at some of those commercially available models and what they’re solving for.

You’ve got to start somewhere. You start with somebody else’s product and at least learn that well, then you’re going to figure out what works for you and doesn’t work for you.

Yes, because you’ll say, “This needs to do this,” and it doesn’t. “What am I going to do?”

Brian, anything else you leave the audience with as far as common mistakes or maybe some that we wouldn’t think about when underwriting or things they should be keeping in mind?

Underwriting is the most important piece of this business. It’s not about finding a good deal. It’s about properly underwriting the deals that you do see so that you can project the returns to your investors. This is all about setting expectations. When you set expectations properly with your investors, you’re going to have happy investors. You set them improperly, you’re not. Happy investors repeatedly invest, unhappy ones don’t and they don’t tell their friends. Happy ones will spread the word, so underwrite properly and you’ll build a good business. Get too aggressive or mess it up, it’s going to be a short career.

[bctt tweet=”Happy investors repeatedly invest. Unhappy ones don’t, and they don’t tell their friends.” username=””]

I may have asked you this, but I’m going to ask you again to tell the audience the one thing that’s contributed to your success, maybe other than proper underwriting.

I think the big thing that contributed was my background in house flipping of all things. Buying cheap houses and fixing them up and reselling them. It gave me some fundamental experience in construction. Fundamental experience in the acquisition. Fundamental experience in underwriting but moreover, it gave me a loyal following from investors who are funding the activities that grew with me and helped spread the word when our business grew. It’s just like any 100-year-old tree started as a seed or a pine cone. It’s okay to be a pine cone and I was a pine cone and we’ve grown a lot as a result.

Tell the audience how you like to give back.

I like to give back two ways. One is in our, I participate heavily in forums. Through our charity,, where we’re going to be giving away all fixed up and free and clear house to a deserving US service member, veteran or first responder. We’re raising money for that charity.

How can the audience get in touch with you, Brian?

The best way is either through BiggerPockets or through our website

Brian, thank you again. You’re definitely an expert in this business. We always appreciate you sharing with the audience. I appreciate the audience being with us. I hope you’ll go to Life Bridge Capital and connect with me. Go to the Facebook group and ask your questions on there so I can ask them to these guests experts like Brian. We will talk to each of you next time.

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About Brian Burke

RES 277 | Underwriting PropertiesBrian Burke is President / CEO of Praxis Capital Inc, a vertically integrated real estate private equity investment firm. Praxis operates on multiple platforms, currently managing active syndications for the acquisition of multifamily, single-family, and opportunistic residential assets in US growth markets.

Brian has acquired over $400 million in real estate over a 30-year real estate investment career including over 2,500 multifamily units and more than 700 single-family homes, with the assistance of proprietary software that he wrote himself. Brian has subdivided land, built homes and constructed self-storage, but really prefers to reposition existing properties.

As a recognized expert Brian has been a frequent speaker at real estate forums and conferences; including the SF Bay Summit, Opal Family Office & Private Wealth Management Forum, the Keiretsu Real Estate Forum and the Institute for Private Investors. He has also served as co-host and real estate expert on the Fox News Radio show, “The Best of Investing”.

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