Underwriting Multifamily the Right Way, Part 1

Few phrases are more irritating in the world of real estate than, real estate is all about the numbers. Real estate is as much about the numbers as a painting is about the paint, or a book is about the letters. Letters are needed to write a book, to be sure. And paints are needed in order to create a painting. But, these are just building blocks we use to tell our story of truth. 

It’s All About the End

How we write the story is a function of what we want the story to end up being. The same is true about the way we mix our paints – the end result is what is important, not which paints we mixed and how. How we invest, which vehicles we use, which markets we play in, this is all a function of our desired destination.

From here, once we see the end, we can walk it back to arrive at all of the building blocks we’ll need to actually get there.

Important Distinction

Real estate is not about the numbers any more than paintings are about the paint. Real estate is about the story, and numbers are there simply to tell this story. An important yet uncomfortable distinction here is that people who understand storytelling in real estate are able to manipulate the numbers much the same way a painter is able to manipulate paint to tell whatever story suites them. So for you the question is, are you looking for their story upon which to base your investment decisions, or are you going to write your own story?

Call it my sense of the obvious, but a selling broker’s objectives may be somewhat different from yours. His job is to sell you a building. Your job is not to lose your shirt. So, perhaps a little less looking at the numbers, and a little more story-telling is good here…?

In the following few articles, I’ll attempt to present to you the story, at least in the very broad strokes. Each time I sit down to underwrite a new opportunity, I methodically put numbers into a spreadsheet which contains about 8 pages. Each page is there to address a specific part of the story. Today we are going to begin with Page 1 – Stabilized P&L.

Stabilized P&L

I call this page my back of the napkin underwriting. The reason I refer to it as back of the napkin is because while it tells a complete story in many ways, this page is static in nature. Of course, all of us know that any realistic story in real estate cannot be static – things change every week, month, year. A good underwriting model has to address all of these dynamics. But, we have to start somewhere, and for me it’s the Stabilized P&L on page one of the underwriting.

There are several questions being asked at this first stage, most importantly: if this asset were operating to its’ best capacity, what will that look like in terms of all of the line-items in the P&L?

We are painting a picture of stabilized operations here. Naturally, we are not buying a stabilized asset, and it will take money and time for it to get there. But, if it were there today, what would that picture look like…?

Let’s look at some of the line-items to consider.


Literally, nothing is simple in this game. Even a simple concept of income is something to discuss. There are different types of income. All of them are discounted and synergized into what’s known as Effective Gross Income – this is essentially your expected collected top-line number. But, the process of arriving at the EGI involves several steps:

Step 1 – GSR

GSR stands for Gross Scheduled Rent, and this is easy enough to understand. You simply price gross rent for each of the unit types and multiply by the number of units in the type. So, if you never had a vacancy, never had an eviction, never offered any discounts, etc – this would be how much rental revenue comes in.

Now, how you price these rents is crucial for a lot of reasons. Being off by $10/month is a big deal. But, that’s for another time.

Step 2 – Economic Losses

While it would be wonderful if everything always went perfectly, but nothing ever does. So, in our underwriting, we have to allow for the story of imperfections. The following subsection of the underwriting is called Economic Losses and it includes the following line-items: LTL, Physical Vacancy, Concessions, Credit Loss (Bad Debt), and Non-Revenue Units.

We could spend a long time discussing what these are exactly, and we could spend an even longer time talking about the why, when, and how of each of the above economic losses. We could represent these as a percentage or per door dollar costs, and there are accepted norms which we baseline on. Remember, you are telling a story, though, so whether you use percentage or dollars you must first understand the story – the why, when, and how, and then boil it down to the numbers. This is an article of its’ own.

But understand this – even though you are not necessarily writing checks to cover these items because they manifest in the form of lost revenue, they are just as real as any other cost/expense. Economically speaking these inhibit your bottom line by discounting your top-line.

You won’t hear many people talk about these items. However, I have to tell you that not paying due respect to the economic loss items will cost you lots of money. I should also tell you that prudently the minimum stabilized economic loss I’d recommend you use is something around 8%. I won’t tell you that you couldn’t outperform. But, It’s not safe to underwrite anything less in my opinion.

This means, boys and girls, that even a stabilized property, one functioning at capacity, will lose 8% of its revenue before you pay a single bill. Let me say that again, so you get it:

Even a stable property will lose about 8% of its top-line before you ever write a single check for a single service or cost. Internalize this.

Step 3 – Effective Rental Income

Thus, you take your GSR from Step 1 and discount it by the amount of your economic loss, and this gets you to the Effective Rental Income. Effective income is income after the economic losses.

Step 4 – Auxiliary Revenues

In most income-producing assets the income is comprised of actual rents and auxiliary revenues. One of the biggest auxiliary revenues has to do with utilities. Whether RUBS is utilized, or a simple fixed bill-back, the utility income gets its’ own line-item in our underwriting. There are accepted norms for this line-item, but this is very subject to everything from asset class to location, so telling the correct story is very important here.

Aside for utility income, there may be some additional income streams. Things such as pet fees and deposits, late fees, insufficient funds fees, early termination fees, laundry income, parking income, storage income, and more. We combine those into another line item in this section. And, true to form, while there are national baseline statistics for these, it’s all about your specific story.

Step 5 – Effective Gross Income

By adding the auxiliary revenues from Step 4 to the effective rental income from Step 3 we arrive at the Effective Gross Income (EGI). This is the income we would expect our asset to be capable of generating on an annual basis.

Feel free to ask questions below, guys. More coming next week.


  • Ken Reply

    Ben, Great Info. I was questioning whether I am too conservative in my underwriting. Brokers say “yes” – but its my money so I listen to the numbers not the sellers’ broker. But your analysis of economic losses add a dimension, other than vacancies, I never considered. I’m used to calling out sellers for excluding obvious expenses in their pro forma, such as management, lawn maintenance, trash removal, etc, but I would never expect to see or even considered economic losses as you detail in my underwriting. Thank you. I would say that you saved us money, but since it appears to be a sellers’ market, you just gave my brokers another reason to call me unrealistic in my pricing.

    • Ben Reply

      Ken, thank you for reading! All I have to say is that as markets change, so must our underwriting. It is unrealistic to think that in this market we could pay for apartments the same price that we paid in 2013. And interestingly – that’s OK. Why? Because paying today’s prices is only a problem if you think that tomorrow we’ll have a repeat of 2013 conditions. Do you think that?

      This is the mental exercise I went through. Today, I am bullish and definitely want to buy…if it makes sense 🙂

  • Billie Jean Reply

    Thanks for writing this, Ben! When you are underwriting your expenses, what income line do you take your PM, repairs, etc as a percentage of? Do you pay your PM based on effective income? Or does this depend on the specific deal or market?


    • Ben Reply

      Thanks! The PM is paid as a percentage of effective income. In other words the income they manage to collect. Makes sense?


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