How We Underwrite Potential Rents

Correctly predicting gross rental income is one of the most important parts of underwriting real estate- hard to nail it to a T but we get quite close.

Market rents will tell us a lot, but we need to blend:

-Where exactly the property is vs. market rates in this area (you can get $3.50 a sq. foot in a prime location and half that if you're in the same neighborhood but on the outskirts)

-Condition/Amenities (how do you or will you compare to surrounding inventory?)

-Sq.footage (tiny rooms and low ceilings will always make units tougher to lease)

-Floor plan (open lay-outs do best)

Whether the property is vacant and/or needs renovations- we need to source the rates we can achieve given the above and ensure we're not making apartments "too nice" within the scope of the project.

If we execute a luxury renovation to a bunch of 1 bed units, we'll be capped on rents if they're each 400 sq.ft.

After pulling enough listings and talking to enough people, we're able to tailor rates based on the product we’re dealing with.

Every property is different (we once looked at an apartment complex that got zero natural light), just need to account for how and adjust strategies accordingly.

Keep Your Supply Lines Open

One of my favorite books is “How to Stop Worrying and Start Living” by Dale Carnegie.

A famous concept in the book is to “keep your supply lines open,” which alludes to always maintaining a backup plan.

In the context of the work, the open supply line was a job at home that the character could always return to if he was ever in a bind.

For us, keeping supply lines open applies to several verticals:

Network: Treat people well, keep in touch with them, and look to provide value where you can.

-Contractors, potential investors, brokers, attorneys- If you cross paths with good people but couldn’t work with them at that point in time, it doesn’t mean you won’t in the future.

-The foundation guy whose bid was too high might be the perfect person for small masonry repairs down the line.

-The attorney you crossed paths with might be a fit for your friend’s new ground-up development, make the referral.

-The broker who sent over countless deals that didn’t work for you might source a home run in the future- keep lines of communication open.

Underwriting/Asset Protection: You don’t know what’s behind the walls of the property you’re about to buy or what the market will look like 12 months from now.

- Have a plan for when things go wrong and a process to handle each issue (which will likely involve tapping your network).

-Get your renovation costs priced out during the inspection period but account for the issues you can’t see so your budget doesn’t get whacked when they find rotted framing.

-Be conservative with leverage (debt can either amplify returns or crush you).

-Stress test your property and make sure you can survive a ~25% decrease in rates (this also points to conservative leverage).

-Place appropriate insurance coverage on assets and make sure the replacement costs listed in the policy are accurate (construction costs are different today than 10 years ago) – if the property burns down, at least you’re not losing everything.

-Buy assets in good locations- related to the concept above, if you lose everything, you still have good dirt.

Reserve Capital: Processes will take longer than expected, things will break, and hang-ups may occur.

-Account for holding costs (then extend your projected timeline) so you don't run out of money during the renovation period and take guys off your job site.

-Maintain cap ex, vacancy, and maintenance reserves- If you're not budgeting for these, a major repair could incinerate your returns.

We can’t predict everything but we can better position ourselves to take the punches and still execute.

Seeing the Scope

Great excerpt from this morning’s Bright Build newsletter by Sean Sweeney:

“And often, what the seller needs is for you to understand what the property means to them in the context of the wider neighborhood. Remember that I specialize in urban infill. I want to find parcels of land that are just big enough to carve out space for design-forward apartment homes for new tenants. And, I’m not knocking down shopping malls to do that. I’m developing a gas station and a corner store. Three neighboring houses. Maybe a vacant lot overgrown with weeds.

Which is to say that those sites likely mean something to someone else quite separate from my developer dreams.”

The importance of seeing the full scope of whatever project you may be targeting.

Each asset has a story and uncovering it can be a major catalyst for getting the deal done and better serving the surrounding community.