If you’ve taken my advice, you are evaluating deals that you are actively finding. You’ll look at 100 of them before even 1 looks good. You are rejecting deals left and right. Then suddenly, one that meets your criteria and initial evaluation works. Now it is getting real and you have a lot of work to do.
I started writing this and it became way too long, so it’ll have to be a series. This series of posts will tell you the steps I take to determine if a deal is good (underwriting).
Underwriting Overview
Underwriting is the term I use to separate it from the initial evaluation and secondary evaluation that I do. The steps are: initial evaluation, secondary evaluation, underwriting. They are all different and have their purpose. Don’t skip them or put them out of order. The first two are used to rule out deals. They are never used to rule them in. Make sure you take that to heart or you’ll be buying terrible deals.
Initial Evaluation
The initial evaluation is looking at the 100s of deals that are terrible you have to look at before 1 stands out. Because there are so many, you will have to be quick about this. At this stage, you are weeding out deals based on simple stuff. It’s critically important that you’ve developed a criteria prior to looking. The criteria are your must have things like price, location, size, and amenities. Any that don’t fit and you’ll dump the potential deal.
Secondary Evaluation
If it fits your initial criteria, then the next step is to run the numbers. This takes time, so I developed a multifamily quick evaluator that helps me evaluate it in 5 minutes. Send me an email if you’d like a copy. The secondary evaluation takes the numbers given by the seller and calculates an NOI, which you use with the capitalization rate to arrive at a value. You’ll look at this deal against your required numbers for cash on cash return. If it doesn’t meet your numbers, then you dump the deal here.
Underwriting
Underwriting is the deep dive into the numbers. This takes many hours of work (10-20 for me) and you can’t do it for every deal that you find. This step uses the most honest numbers you can get (meaning never simply trust, but verify, and consider risk). To get those numbers, you will need to be under contract.
To correctly underwrite, part of your time is spent gathering data and we will talk about how to do that in a later post. With this data, you’ll need to analyze the income and expenses to arrive at metrics such as cash on cash return, IRR, and equity multiple.
After that is stress testing and looking at the numbers with an eye to the exit strategy. The underwriting step is the deep dive and is the one you use to rule in the deal. If it works, then go to closing and be happy with your new purchase that you accurately vetted! Next week we will look at the first step, the initial evaluation.
