Hot City!

2. Underwriting Income of a Potential Multifamily Property (From the Multifamily Millionaire)

Underwriting income is the process of verifying:

• How much a property is currently earning.
• How much that property could potentially generate with certain changes to management or facility upgrades.

Underwriting income involves analyzing the information included in the rent roll and identifying comparable properties and market rents, followed by calculating gross potential rent and effective rental income.

A. Review the Rent Roll and transfer the information to a spreadsheet

• a typical rent roll includes the tenant name, unit number, unit type(how many brs, bas), square footage of each unit, market rent, contract rent, vacancy loss, other charges or income, current balance, security deposit, move-in date, date of last rent increase, and lease end date.
• use your spreadsheet to sort by to sort by unit unit type and get rent averages for each unit type, this is called the UNIT MIX.
• Analyze the trailing 3 months (T-3), trailing six months (T-6) and trailing 12 months (T-12) to see how income has changed in the last 12 months.

B. Determine the Gross Potential Rent

• GPR = # of units x Market Rent per Month x 12 months per year
• You can determine market rents by identifying rent comps – a basket of properties that are as similar as possible to the subject property in terms of location, age, condition, and amenities.
• free sources for rent comps – Apartment Finder, Aopartments.com, Craigslist, Trulia, Zillow

C. Determine Effective Rental Income

• Take Gross Potential Rent and subtract the economic losses you can reasonably expect to result from Loss to lease (LTL- the gap between the market rent and the rent that is currently being collected.) Vacancy Loss, Bad debt, concessions, and any nonrevenue units.

D. Determine Other Sources of Income

• utility reimbursement, pet fees, laundry, administrative fees, late fess, the sale or rental of other services.

E. Calculate Effective Gross Income

• Effective Gross Income = Effective Rental Income + Other Income

F. Identify Value-Adds

Value adds are ways to boost a properties income by adding value. This can be achieved through the growth of anxillary income, upgrades, and eliminating Loss-to-Lease (LTL).

To capture your value adds in your underwriting,

• Come up with a budget for any projected capital expenditures or unit upgrades
• with budget in hands, project how the value-add changes will affect the property’s income going forward.
• Determine the net financial impact each year for the value adds and add back to the project income streams for each year.

D. Complete Pro Forma Income Projections

• Take your assumptions and use them to extrapolate your income forward. Enter the T-12 income numbers, and then complete projections for each year that you plan to hold the property.
• Most multifamily investors will have hold periods of five to seven years, which gives them enough time to execute on any value-add strategies and fully realize the associated returns.
• Pro forma income should be projected for up to ten years based on the rent data and trends identified in the screening process and underwriting.
• Real estate is cyclical, so all long-term rent projections must by taken with extreme caution.
• most investors won’t assume a long-term rent growth of higher than 2.5 to 3 percent.