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Ace Your Investment Deals With These 6 Underwriting Tips

Investing in multifamily syndication deals can be intimidating for first-time investors. In truth, even experienced investors can be overwhelmed by the numbers aspect that drives the deal. Sorting through all the statistics and figures needed to form a sound financial decision on deals that would yield strong returns is no easy task. That’s why underwriting has become a critical step in the investment process.

In this article, you’ll discover pieces of advice on underwriting multifamily syndication deals shared by Rob Beardsley of Lone Star Capital Group. In our latest conversation, we looked at underwriting through the lens of the passive investor, and identified key metrics to consider in assessing risks, estimating returns, and determining if the investment is viable.Read on to learn what questions to ask and what numbers and records you should look out for in evaluating prospective investment deals. If you want to listen to the full podcast, click here.

Underwriting: A Passive Investor’s (LP) View

Knowing key indicators that drive the underwriting is helpful when evaluating a deal. Some investors make investment decisions solely based on who the sponsor is. While this is very important, there should be an added layer of due diligence which is the financial or numbers aspect. 

Rob cautions that the numbers presented to investors must be verified as factual and accurate. As an investor, the numbers you’re looking at must be truly historical and achieved in the past, with nothing being projected out into the future. However, there are cases when tax adjustments in historical financials are necessary, such as tax reassessment when purchasing value-add property.

What Numbers Should I Look Out For?

Entry Capitalization Rate (entry cap rate)

The entry cap rate is the number used to indicate the forecasted rate of return on an investment deal upon purchase. It is calculated by taking the net operating income (NOI) and dividing it by the value of the asset. The higher the cap rate, the higher the ROI. An investor may use the cap rate to validate a good purchase, forecast a sale price, or when presented with options, make a comparison among deals as to which one would yield better returns. 

However, investors should be wary of cap rates that are made to appear better than their actual value. This could happen for older properties that have not been adjusted for taxes and have very low current assessments. So, care should be taken by the investor to factor tax adjustments into the cap rate to see how much income you are purchasing for your dollar.

Exit Capitalization Rate (exit cap rate)

The exit cap rate, on the other hand, is the cap rate at sale, projecting the value at which the property will be sold at a specific period. An investor must ensure the exit cap rate is higher than the entry cap rate. A higher exit cap rate means the syndication team is projecting that the market will be worse at the time of sale and ensures the deal makes sense even if the market is worse. In this way, your investment is still risk-insulated. Generally, an investor is protected at an exit cap rate of 50 or 100 basis points (0.5% or 1%) above the entry cap rate.

Trailing 12-Months or TTM or T12

T12 is a financial profit and loss statement that shows a property’s previous twelve months of operations. An investor can review the T12 to evaluate the most recent monthly or quarterly data rather than look at older figures covering full fiscal or calendar year information.

Trailing 12-Months or TTM or T12

A rent roll, used by landlords to manage a property, shows data about the rental property’s past rent collection, paid and overdue rents, and tenants’ lease agreements. It gives a view of the historic and potential income of the property. An investor may examine the rent roll to check if the property has been generating stable income, forecast anticipated rental income, and find out whether there’s room for rent increases for higher profitability.

2% Year-Over-Year Growth

Rob advises investors to look for a stabilized growth in income of 2% after the business plan has been achieved. The growth on a property through forced appreciation, i.e. spending money on added or updated property features,, improving management to increase rents and decrease expenses, etc. usually occurs in years one to three. After this period, the property should stabilize and there should not be outsized growth embedded into the underwriting, explains Rob.

Rent Comparison Data

An investor may also explore rent comparison data to get a picture of the property’s competitiveness with similar neighboring properties and its outlook for profitability.

Rob summarizes the evaluation of a multifamily syndication deal down to: what’s the deal, what’s the market, and who’s the operator. Simply put, underwriting is essentially homing in on the details of the deal in its current market environment. 

“At the end of the day, when you are in the syndication business, you are investing in people and not deals,” Rob concludes, highlighting the fact that ultimately, an investor’s decision lies in putting trust in the deal sponsor. “You can’t put numbers on trust or people but underwriting takes care of half the page”, he ends.

Final Thoughts

Underwriting a deal and understanding its financial nuances is key to successful multifamily investing. Getting information may be challenging, but with due diligence, you will be much better equipped to avoid pitfalls, avert risky investments and focus on real opportunities to help you grow your money faster.

Reach out to us if you’d like to learn more about passive investing in multifamily real estate. Our team will be glad to assist you with any questions you have about deals you’re considering. Please email us at whitney@lifebridgecapital.com or call to see if LifeBridge Capital’s investments are a fit for you.

Helpful Links: 

Rob Beardsley on LinkedIn

Lone Star Capital Group Website

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