Hey, There
As I've been having conversations with prospective LPs regarding our fund, I've been getting tons of questions lately about our underwriting approach (especially given that many of our LPs are also invested with other sponsors in deals that haven't gone well). I thought it would be helpful to share how we pressure-test every assumption before risking a dollar of investor money.
The difference between a home run and a disaster often comes down to three critical assumptions. After watching several operators in my network get crushed by their own aggressive projections, we've developed a systematic approach to stress-testing deals. If a property can't survive our worst-case scenarios, we're never taking it to our investors.
Our exact process:
Assumption #1: Projected rents
This is the foundation everything else builds on. We stress-test what rents we're actually going to achieve once we're done renovating units and begin leasing them.
For example, let's say our base case assumption is $1,900/month after renovations. We don't just run our numbers at that target - we also model what happens if we can only get $1,800/mo.
The critical question: Does the deal still perform if we come in below our projected rent numbers? If the answer is no, we don't move forward, regardless of how attractive the deal looks on paper.
This isn't about being pessimistic; it's about ensuring we have a margin of safety built into every deal from day one.
Assumption #2: CapEx budget
This covers everything we're going to spend on renovating the exterior, common areas, and inside the units. And here's where many operators get themselves into trouble—they underestimate costs and leave no buffer for the unexpected.
We stress-test by modeling what happens if we go over budget. Let's say our base case is $15,000/unit - we also run scenarios where we spend $20,000/unit, because things happen.
Why is this so critical? The worst-case scenario is doing a deal where you have no buffer with your capex budget. When costs inevitably rise, you start making bad decisions about the scope of work you're doing, or you simply stop spending money on your business plan altogether.
This typically spirals into a much trickier situation in terms of tenant quality and projected rents. You end up cutting corners on finishes, skipping planned improvements, and ultimately delivering a product that can't command the rents you originally projected.
We want to make sure we have that margin of safety so we never have to make those kinds of compromising decisions.
Assumption #3: Exit cap rate
This is our projected value at sale when we go to sell the building, and it's one of the underwriting assumptions where very small tweaks create massive downstream effects on your projected returns.
Here's a concrete example: if we're projecting a 6.5% cap rate at sale, we also model the deal at a 7.0% cap rate at sale. That's another way of saying the property is worth less when we're done with our business plan than we originally thought.
The questions we're asking: Do we still make money? Do we still meet adequate returns for our investors? Does the deal still make sense?
Even that half-point difference in cap rate can be the difference between a successful deal and one that barely breaks even for investors.
Bonus Key Assumption: Rent growth assumptions
Now here's a bonus assumption that isn't one of the big three, but it's equally important: what are we assuming for rent growth throughout the entire hold period?
Even just a small change in yearly rent growth over a five to seven-year hold period can have massive downstream effects on projected returns, similar to our exit cap rate assumption.
Going from 3% rent growth to 4% rent growth can make a bad deal look like a great deal on paper. That single percentage point difference, compounded over multiple years, can completely change how a deal underwrites.
Our decision framework:
Once we stress-test all these assumptions with more conservative numbers, we ask ourselves one simple question: do we still feel like the deal meets our return targets?
If the answer is yes, if the deal still works with lower rents, higher capex costs, a worse exit cap rate, and conservative rent growth... then it's likely a deal we'll continue pursuing and actually execute on.
If any one of these stress tests breaks the deal, we walk away.
This approach has served us well, especially in today's competitive market where there's pressure to make deals work at any cost. We'd rather pass on a marginal deal than put investor capital at risk on assumptions that might not hold up once we close.