Ever feel like you're trying to predict the weather a year from now while blindfolded? That's what underwriting multifamily deals can feel like if you don't know where to start.
“I don’t know how to accurately underwrite deals, and I'm afraid of making a mistake... which is holding me back from making offers.” — I get it. Underwriting is a critical component of the investing process... if you miscalculate, you could end up buying a bad deal, and that fear keeps many investors from moving forward.
Most multifamily investors are intimidated by all the different components of underwriting deals, and while I won't dive into every aspect of multifamily underwriting in this email, there are two assumptions investors must get right.
After reviewing hundreds of deals and seeing where other investors crash and burn, I've noticed two critical mistakes that can turn a promising investment into a financial face-plant faster than a toddler on a skateboard.
Mistake #1: Miscalculating Stabilized Rents
When you get your rent projections wrong, it has a direct and significant impact on your bottom line. Here's why:
Your expenses (taxes, insurance, utilities) stay roughly the same whether you're leasing units at $1,500 or $2,000 per unit. Miss your rent target by just $100 per month across 50 units, and suddenly you're short $60,000 annually that would have dropped straight to your bottom line (NOI).
Mistake #2: Underwriting The Wrong Exit Cap Rate
A tiny 0.5% error here can devastate your returns. Consider this:
A property generating $100,000 in NOI:
At a 6.5% cap rate = $1,538,461 sale price
At a 7.0% cap rate = $1,428,571 sale price —nearly 10% less!
That innocent-looking half-percent difference just cost you nearly $110,000 – which can turn a bad deal into a seemingly good deal.
How Our Underwriting Has Evolved to Handle Today's Uncertainty
With interest rates and inflation looking to stay elevated through 2025, we've adapted our underwriting criteria to ensure we're not overpaying (and buying bad deals). The multifamily market isn't likely to see significant rent or value growth this year, so we're getting more defensive.
Our secret weapon? The spread between yield on cost (YOC) and market cap rate.
Here's how it works:
Calculate yield on cost: Total cost (purchase price + renovations + closing costs) of $1M ÷ $100K in projected NOI = 10% YOC
Compare to market cap rate: If the market is at 8%, your spread is 2%, Why do we care about this spread? If the property is valued at an 8 cap, it's then worth $1,250,000 when the project is complete (creating $250K in equity!)
In today's environment, we're widening that spread to 3% or more. Why? Because it gives us a larger cushion against:
Market uncertainty (economic changes, stubborn interest rates, etc)
Business plan risks (going over budget on construction, tenant issues, etc)
Potential downward pressure on values
Put simply...
We're more diligent about buying deals at deeper discounts than we would have a 1, 2, 3+ years ago.
This single adjustment has prevented us from overpaying for deals while other investors continue buying deals with less margin, where there's a higher likelihood of the deal going sideways. It's like wearing a life jacket when everyone else is hoping they remember how to swim.
Want to dive deeper into these underwriting strategies? I recently recorded a podcast episode that covers this exact topic in much more detail:
Listen to episode #270: How To Easily Adjust Your Underwriting To Compensate For Uncertain Market Conditions, Deal Risk, Etc + Launching The Multifamily Wealth Community!
Available on Spotify too: