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Steps That Will Stop You From Getting Burnt on Multifamily Deals

Want to know how to analyze a multifamily property? Maybe you’ve analyzed duplexes, triplexes, quadplexes, or even ten-unit apartment complexes before, but what about the big deals? We’re talking about multi-million dollar multifamily investments, with hundreds of units, large debt and equity structures, and many, many small pain points only experienced investors would notice.

If you’re looking for an in-depth overview of how to find, analyze, and buy a large multifamily property so you can build passive income and serious equity growth, then Andrew Cushman is the man to talk to. Andrew is so good at what he does that he’s partnered up with BiggerPockets Podcast host, David Greene, to invest together.

In Andrew’s previous episode, he touched on the “phase I underwriting” that comes with analyzing a multifamily deal. In this episode, Andrew focuses on what investors should do after they’ve triaged their deals and are left with only the best in the bunch. Andrew spent years worth of time analyzing deals to come up with these eight steps. He shares them today so you can have less headache and more investing success than when he started!

David:
This is the BiggerPockets Podcast show 586.

Andrew:
Do not fall for the temptation of actual cash value insurance policies. In most cases, a lender will not let you do that. But if you’re buying a property for cash or you’re doing some kind of non-traditional debt structure, don’t fall for the trap of, “Cool, I can save a little bit on my premiums,” because the minute you have a loss, that will come back to bite you big time.

David:
What’s going on everyone? It is David Greene, your host of the BiggerPockets Podcast, the show where we show you just how powerful real estate investing can be. Our guests include food servers and firefighters, counselors, and corporate execs, people with a wide range of backgrounds with one thing in common, they got the real estate bug, they got educated and they took action.
Now it’s our job to help you do the same. Now we are going to do that today by bringing in my personal friend and multifamily investing partner, Andrew Cushman. Andrew Cushman has been on this podcast several times. I believe this is his fourth appearance and he is a multi-family investing specialist. On episode 571, we dug into what he calls phase one of his underwriting, where he looks at would this property possibly work if everything went great?
In today’s episode, we get into phase two where we verify is everything actually great and could this deal work? Now, this is a very, very detailed, practical sort of information packed episode where you could take the information and literally create the same system that Andrew runs. And I hope that many of you do. If you’ve ever learned what goes into analyzing multifamily property, this might be the most important episode or piece of information that you watch ever.
This will teach you more about investing in multifamily property than you probably ever heard in your life. And that doesn’t mean that you need to actually go do everything we talked about, but this will give you amazing insight into what goes on that will give you confidence in your own investing and maybe help you understand if multifamily is a niche that could work for you.
There’s all kinds of different strengths and weaknesses associated with each asset class of real estate, and today we dig in pretty deep on what goes in to multifamily investing. Now there’s eight steps that I’m going to want you to follow. And at the end, Andrew and I talk about a deal that we’re going to be putting together that you can get more information on. So make sure you listen all the way to the end to learn about that.
And if this is your first time hearing about Andrew or multi-family investing, please go back and listen to episode 571 after you finish this so you can see what led up to it. Now, if you end up liking this episode and you’re like, “Man, I like learning about something new that I didn’t see coming.” Today’s quick tip is going to be to go to biggerpockets.com/store and check out the books that they have.
There’s books on all kinds of topics, and it’s good to read them just to get a feel for if you would like investing in that type of asset class. And if that’s really where you want to put your focus and attention and learning to grow, the other thing you can do is get on the BiggerPockets forums and ask questions and see how many other people are thinking the exact same things as you, and trying to figure out the same questions that you’re trying to figure out.
So many of us think that we’re on this journey on our own, and we’re really not. Everyone else is taking it with us. So get hooked up with some people on this hike and this journey to the top of the mountain that we’re all taking and will be very encouraging for you. Without further ado, let’s get into it with Andrew Cushman. Andrew Cushman, welcome back to the BiggerPockets Podcast.

Andrew:
Hey, good to see you again. I think it’s going to be a great day. I put the left earbud in my left ear on the first try, that’s always a good sign.

David:
Is that your barometer to tell how things are going to go?

Andrew:
Yes, it’s very predictive, yeah.

David:
I like it. People are getting in behind the scenes look on just how to be successful in real estate investing.

Andrew:
That’s the key right there, yeah.

David:
Now today’s show is going to be a masterclass on underwriting multifamily properties. So heads up if you’re not into multifamily, this is one that is definitely going to be focused on that niche specifically. But I think that there’s value that you’ll get out of this anyways because we’re going to go into really the fundamentals of real estate investing.
The specifics of how to evaluate multifamily are going to be covered but there’s always a why behind what we’re doing. Now, we had Andrew on episode 571 where we went over what Andrew first was phase one of his underwriting when it comes to multifamily properties. Could you give us a brief summary of what those six things were?

Andrew:
The phase one underwriting was just, and we won’t go through all of the different steps, but the phase one underwriting was just a quick and dirty like you’ve got 10 properties in your inbox, you did the screening that we talked about way back in episode 271, I think it was or 279 yeah, 279 and you said, “Okay, well these three look interesting.”
But you don’t want to spend eight hours underwriting them so you just go through and make some fairly positive assumptions about rent growth, expenses, your debt, all of that and look at it say, “Well, okay I spent 30 minutes, 15 minutes underwriting this.” Under the best case scenario, these rosy assumptions, the deal doesn’t work, trash it, right?
But if under those rosy assumptions, it does look like a great deal, that’s when you move to phase two, right? Because you’ve done the screening, you’ve done phase one, the cream rises to the top but turds float there too. And phase two is where you’re going to figure out that if the property in question, which one of those it is.

David:
The turd test.

Andrew:
The turd test, yeah.

David:
Brandon is not here so that’s probably the best that I can do coming up with names.

Andrew:
All right, well, we’ll take it.

David:
Okay, so we also talked about the four levers that really, really make a deal work. Can you go over those briefly?

Andrew:
Yes. And there are other levers, but as we discussed, these are probably four of the most powerful ones. One are your rent growth assumptions. So did you assume 2% rent growth or 3? And over a five year timeframe, that’s cumulative and it has a huge effect. The second one was, what are your cap rate assumptions? Did you assume cap rates stay flat? Did you assume they go up 100 basis points or 50 basis points over your whole time? That changes things significantly. Especially if you’re looking at IRR.
The third one is the time of sale. Are you planning on underwriting for a three year sale, a five year, 10 year? What if you’re going to hold it indefinitely? Moving that endpoint significantly affects how you underwrite and are you looking at IRR or cash on cash? So that’s another huge lever.
And then the final lever we talked about was leverage itself. Are you going in with 65% LTV debt, loan to value, or are you trying to max it out at 80 with a bridge loan? Are you trying to put preferred equity on top of that to get to 90? So those are the four levers that we went in a lot more in depth and that can very significantly affect your underwriting.

David:
And you really want to understand those levers because if you’re going to invest as a limited partner in somebody’s syndication, they might have fudged the numbers by putting these levers in places that aren’t natural. So for example, we mentioned cap rate assumptions. If you’re not super into multifamily, all that means is a cap rate is a measure of how desirable an asset is in any specific market.
The lower the cap rate is, the more people want it and the lower a return an investor will accept to get into that market. If a general partner or the syndicator is assuming that demand is going to go up, meaning cap rates are going to go lower, they can make the deal look a lot better on paper than it’s actually going to be.
When Andrew does deals and when we do deals, we assume the opposite. We assume cap rates are going to go higher, which means that there will be less demand. And it’s a more conservative approach. If the deal still works under those conditions, it’s much less likely to fail. So that was some really good stuff and just understanding how easy it is for somebody to sort of manipulate numbers when they’re making an offering, as well as you can talk yourself into a deal being a good deal by kind of playing with those levers.

Andrew:
Yeah, you’re a hundred percent right. It applies both ways. If you’re looking to invest as an LP, you want to understand the impact that those things have so that you can dive into their underwriting and make sure that either they are not intentionally pulling a lever they shouldn’t, or just unknowingly pulling it, or be maybe you just don’t agree with their assumptions.
And then yeah, if you’re doing your own, you can make a spreadsheet tell you anything you want. And so you got to be cognizant that you’re not doing that. Well, if I just assume the cap rate doesn’t move, this is a great deal. Real world is often different than spreadsheets so be careful.

David:
And we’ve all been there. That’s exactly right. So phase one like you mentioned is just, hey, if we assume the best does the deal work? Because if it doesn’t work under best circumstances, don’t look at it all. And it doesn’t really take that much time. And another thing I really love about the system Andrew has here is this can be leveraged to other people.
So Andrew, you have two people on your team that for the majority of these deals, they’re actually working phase one underwriting and they’re only coming to you or putting more time into it if it passes phase one underwriting. So anytime you can create something like what you’ve done here, it makes it easier on yourself to leverage anything you want to add on what things have been like since you made that change.

Andrew:
So it used to be me looking at everything and doing every step and it was brutal. And I started to get burned out on it where a deal would come to my inbox and I’d be like, “Oh geez, another deal I got to underwrite.” And I lost the excitement, right? Whereas now we have a virtual assistant that’s worked with us for a couple years now who does that screening process that we talked about way back on 279.
Then I have an acquisitions person who does that phase one underwriting that we talked about in our last episode. If a property looks like it’s cream and not a turd, then he sends that to me, we talk a little bit, he then goes into phase two and then he proceeds from there. So when you go to phase two is it’s screened well, it passed phase one underwriting and it looks like a property that you want to own and, or you think is at least worth putting an offer on.
And that’s a whole nother topic to get into on another time but there’s a lot of different reasons you’d want to put an LOI on a property even if you might not necessarily want to win the deal on the first bet. This is the process phase two that helps you decide what price in terms that you would consider doing that. And so this is definitely more time intensive. So you don’t want to do it on every deal, only deals that have high potential or properties that you think you’d really want to own.

David:
All right, everybody. So buckle your seat belts because you’re about to get some high level practical information that you can actually take away from the podcast and apply the minute that you leave into evaluating a deal. There’s going to be eight steps to underwriting phase two. Anything you want to add before we get into those?

Andrew:
Yeah. So if you’re used to listening to podcasts on 2X speed, don’t do that because I’m already going to be talking fast.

David:
That’s a great point. All right. So what is step number one?

Andrew:
Step number one, rent increases. So there’s a number of components to this. There’s market rent growth over time. There’s hopefully you have found a value add deal so there’s a component of bringing the property up to where rent should be today. And then we’re going to talk about actually step two, is loss-to-lease.
And they both factor into rent increases, but we’ll save loss-to-lease for just a minute. So far as regular rent increases. First, we’re going to talk about… We talked actually in phase one about market rent growth over time. That’s where you’re assuming, okay, market’s going to keep going up 2 1/2% or 3% a year. But how you determine where market rent should be today is we use what’s called a scatter chart in Excel.
And I’m going to pull up a visual here. If anyone is just listening and you’re not on YouTube, we try to explain this so it’s understandable but the best thing to do is go to YouTube and take a look at the chart that we’re showing. So what you’re seeing now is a one bedroom rent comp analysis. And by the way, these are real, we didn’t make this up.
These are from deals that we actually have offered on. We did take out the name of the actual property so we don’t have a hundred thousand people going to look at it, but this is real data. And in this example here, we’re looking at one bedroom rent comparables. And you’ll see on here there’s Oceanside, East Park, Laurel Creek, Westview, Whispering Pines, these are all comparable properties to the one that we’re looking at.
And on the chart, there’s a bar that’s labeled in red called one by one unrenovated. That is an unrenovated unit at the property that we are doing our phase two underwriting on. And how the chart works is the bottom access is the square footage, right? So as you move from left to right, that means a smaller unit to bigger unit. The vertical access is rent. So on the low end, this chart starts to 800 and it goes up to 1200.
And so what we do is you take all these… When you get a bunch of data from Axio or CoStar, wherever and all this different floor plans and different sizes and rents, it’s kind of hard to just look at all that and figure out, “Well, okay, where’s my rent?” Right? So you make it visual. And so what we do is we take all those data points, we put it into Excel and we create this scatter chart.
And then if you look there’s a blue dotted line that kind of goes from bottom left to upper right it’s called the regression line. There’s a nasty statistical definition of what that means, but basically it’s just a visual line that shows how the different data relate to each other. And what you’ll see is the reason the line goes up from left to right is because rent tends to increase in that market as the unit size goes up.

David:
As the property gets bigger.

Andrew:
Yeah, as the units get bigger. People generally are willing to pay more money for larger units. And the steepness of this line kind of tells you how much that submarket values a bigger unit. But the most important thing that we’re trying to show here is if you look at our one by one unrenovated unit, it is sitting at $900 a month in rent. Every other property is a thousand dollars or higher, right?
So by plotting these, you can immediately look at this and go, “Well, okay, I should be able to do a light renovation and at least get the rent from 900 to 1,000.” All right? And if you look at the chart, you’ll see that we actually have the one by one renovated is the one that’s in green at 1,025, which is slightly above two of the other data points.
Well, all right, Andrew, why is that one higher? Right? If the regression lines right at 1000, why do you have it as 1,025? Because part of our analysis is we looked at those other comparables and saw what the interiors were like and said, “Okay, well, if we spend $6,000 or whatever the number was, we can meet or exceed those plus our professional management with a lot of experience in that market, we have high confidence that we can get to 1,025.”
So that is what we’ve found to be the most effective way to quickly and accurately at the same time determine how much rent bump you can get, right? Again, there’s more like if you’re buying a property, you’re going to go visit these property and actually tour these comps and all that. But when you’re sitting at your desk doing phase two underwriting saying, “Okay, I assumed in my phase one that I can raise rents a hundred bucks a month or 150, is that true?” This is where you’re verifying if that rosy assumption was true. And based on this chart, these units should pretty easily get to about 125.

David:
Now I see you have several different complexes that looks like all the different names of them. How did you go about gathering the data that you put into this chart for what Whispering Pines gets Westview, Laurel Creek, et cetera?

Andrew:
Good point. So we try to get it from as many data sources as possible. So we’ll get it from Axiometrics, CoStar. And anyone who’s tried to sign up for CoStar is like, “Andrew, that costs an arm and a leg.” You’re right. So we don’t pay for it. We go to brokers and property management companies that do and say, “Could you please send us a report for this submarket or for this property?”

David:
Nice.

Andrew:
ALN is another source of data. But also what we do is we perform our own surveys. We will get online and look up every property just using Google, apartments.com, rent.com and get every property in the area, call them, get it off the internet, get all own data, and then ideally we have two or three sources for the same data set. We compare them and try to get them to line up as much as possible, and then plot them on this chart.

David:
Wonderful. Okay, so tell me how you would… Let’s say that you had a rosy assumption and then you pulled up this chart. What would let you know, “Hey, stop right there. We’re not going to be able to get the rent bump that we’re going to need”?

Andrew:
Yeah, right on. So if it’s one of those things where we had a call with the broker and they’re like, “Oh yeah, you can easily get these things to $1,200 a month. The seller renovated one unit and he leased it for $1,200 a month and you should be able to do the same.” So, okay, cool. In phase one, boom, $1,200 a month. Oh, this property looks great. We do this, sorry, no. It’s only going to be 125, maybe 150 best case scenario. So we go back, change the underwriting and it might kill the deal. So then that’s what you’ve… Again, you look just like in phase one, you’re looking for reasons to say no.

David:
There you go. This is the verify part of trust but verify.

Andrew:
Exactly. Yes.

David:
Okay. Anything else you want to cover before we move on to the next step?

Andrew:
Yeah. You know what? Just to get it all in, let’s go ahead and keep on moving. So the next part of this that I want to talk about is number two, is loss to the lease. And to be fully transparent, I was in the business for several years before I even fully understood what that actually meant. All right? So here’s what loss-to-lease is.
Let’s say you’ve got a tenured apartment complex, and you are advertising that your rent is a thousand dollars a month. But when people walk in the door, for whatever reason, maybe you’re asking too much, maybe you didn’t hire the right leasing person, whatever, when people walk in the door, you’re actually leasing it for 950, right? You’re marketing it for 1000, but when that lease is signed, it’s 950. So how that’s treated is you are losing $50 a month to that lease, right? So market’s 1000, but your lease is 950 so your loss-to-lease is $50 a month, right?

David:
Okay. Let me see if I can make sure that we understand here. What you’re saying is if you’re being told that the unit will rent for a thousand dollars a month, you’re putting it in to your rent estimator at a thousand dollars a month.

Andrew:
Right.

David:
But recognizing that’s not accurate, you looked and see, well, what is it actually renting for? Only 950? So you have to subtract that $50 from somewhere and you create the category called loss-to-lease to do it. It sounds very similar to how vacancy is used. When I was new at investing, I would say, “Well, it’s going to rent for $1000 a month, but I have a 10% vacancy rate so I’ll just put $900 a month in for rent.” That’s actually not the right way to do it. You should put in the full thousand and create a separate category for a vacancy where you take off a hundred. Is that the same principle working here?

Andrew:
Yes, it is. And so what happens is loss-to-lease sounds like a negative thing, and it is if you’re an owner, but if you’re a buyer, it’s an opportunity that you’re looking for. And candidly, loss-to-lease is my favorite value add because it has the lowest execution risk. We talked about the situation where you got 10 units, you’re marketing them for 1000, but you’re actually signing leases for 950.

David:
Can I interrupt you again real fast?

Andrew:
Yeah.

David:
What’s a reason why somebody would put a tenant in at 950 when they’re marketing it at 1000.

Andrew:
We saw this a lot during COVID. People were just nervous and like, “Dude, if I can get someone that’s actually going to show up and pay, I’ll give them a discount.”

David:
So maybe for whatever reason, they had a special running that month where they said, “Hey, get X amount off your rent or something,” that they don’t have to do all the time, but they were trying to lease it up. So they gave that person a discount off of what they normally would get for market rent. Is that accurate?

Andrew:
Exactly. And sometimes you’ll see where the entire tenant base in a property has it, other times you’ll see just a couple of exceptions because it was a friend or they felt bad or they were nervous because of COVID or maybe it was December and traffic was slow and there’s all kinds of reasons.

David:
Okay, thank you. Go ahead and continue.

Andrew:
I’m going to pull up another visual. And this is another scatter chart, looks somewhat similar to the one that we had on the previous slide. And this is another one where you’re looking for a visual to give you a quick reading of what the data is saying. So I started to mention before that loss-to-lease sounds like a negative thing, but in a up trending market like we’ve had for the last 10 years, as a buyer, loss-to-lease is a huge opportunity, and again, probably your easiest value add.
So what we have here on the screen, this is for a property that we actually purchased back in March of 2021. So again, this is real data, real property. And what we did is on the horizontal access, which if I remember from high school as x-axis, we have the date of every lease on the rent roll, right? And then on the vertical access again, is the rent starting at 1150 going up to 1400 in this case.
So you say, “All right, well Andrew, why would you organize the data like this?” Right? So the older dates are on the left, the newest dates are on the right. And then again, rent goes up from bottom to top. So what we did is we’re taking the actual rent roll from the property that has the lease rates and the date that that lease was signed.
And what happens when you plot that on this chart so that you can see the date and the amount that the resident is paying, it becomes very clear when you look at this chart, “Hey, wait a second. Every lease that was signed in the last six weeks, they’re getting 1,350, but the older leases all averaged 1,264.” Clearly, now you need to dig into it a little bit to find out well, did they do renovations or were not?
In this case, and I can tell you this because we bought this property, in this case, they had not done any renovations. They were just finally starting to catch up with the market. And I mentioned before, you might see one lease that’s kind of high, that doesn’t prove a trend. But when you have six weeks consistently of every lease that was signed is all of this is significantly higher, that’s a sign that you can probably buy that property and take all of those other leases, which are represented by very low dots on this chart and get them up to that 1350.
So what you’re looking for are two numbers. You take the rent roll and you average and again, do this by floor plan so this is a one bedroom. If we take every dot on this chart, the average in place rent, meaning people are actually paying it is 1264. But the last 8 to 10 dots on here were all 1350. So what that tells us is we can almost do nothing, just buy the property and manage it well, and then get the rent up from 1264 to 1350. That’s an $86 increase just for managing it and catching it up to market.
Now the reality was now that we’ve owned this property for nine months and the market has continued upward, we are multiples above this level, but this right here not only gives you a huge insight into the opportunity at the property, but it also gives you kind of a backdoor insight into how the overall market is trending. And we have found this chart to be one of the most powerful tools in our underwriting analysis.

David:
Yeah, this is brilliant. Let’s talk about a couple reasons why this is something that should be focused on a lot, but often isn’t. The first thing is like you mentioned, loss lease is the easiest thing to correct. It’s the least expensive and the fastest. You can walk in there and immediately see, “Well, we should be getting this rent so we can bump it up to this before we do anything.”
And you always want to take care of your easiest things first. So if you’re buying a unit that has a very small loss-to-lease or it’s insignificant, in order to increase the rents, it’s going to take a lot more work. You’re going to have to do something like add amenities or upgrade your units, you’re have to spend some money and some time to get there.
Looking for something with loss-to-lease if you were going to compare this to single family properties would be like, you’re getting it significantly under market value. There’s a lot of room to get up to the ARV but even before you do a rehab. Another thing is like when you mentioned, this shows you what’s going on in the market. What you’re referring to is that the higher the loss-to-lease across an entire market, the faster rents have been rising and the leases haven’t expired fast enough to catch up with it. And that’s where you want to be if you’re assuming that that trend is going to continue, which in most cases it is. Go ahead.

Andrew:
Yeah. And I was going to say for those listening who are afraid to buy right now, there is a window of opportunity I’d say for probably the next six to 12 months. There are so many property owners, especially in the, I’d say under 50 unit space where because of COVID fear, whatever, they have not kept up with the rent increases of the last year. And we keep seeing property after property where rents haven’t been raised in two or three years and they are 20% below market now. I don’t think that’s going to last forever, so again, this reveals a huge, huge opportunity.

David:
Yeah. You and I are still finding those deals if you know what to look for. And this is the big red flag that shines, it says, “Hey, come look at me. I am worthy. There’s something here where people are not taking advantage of me.” It kind of reminds me of that old movie She’s All That where you have the nerd that no one’s paying attention to, but really they’re the beautiful princess underneath it.
This is one of those things that you can see, man, this deal would clean up pretty nice. So understandably so that’s why you have it so early in your underwriting process. Because if there’s not a lot here, there’s got to be some that else about that deal that makes it really appealing, that makes you think that you could improve it. This is definitely the best to look for.
And I can’t highlight enough that metrics like this help you understand what’s trending in a market in general. So just imagine that if most leases are signed for 12 months and rent goes up over a 12 month period, let’s say it goes up a hundred dollars over the year, many of those units that signed 10, 11, 12 months ago are going to be at rents that could be going up. And sometimes the apartment complex just extends them on the same lease that they have, right? They’re afraid of vacancy or whatever’s going on. So this is how you can identify that there’s something juicy here. Anything you want to add before we move on to the next step?

Andrew:
Two things. One, if you’re looking for low hanging fruit, this is picked in a basket, sitting under the tree, waiting for you. And then, okay, well, how do you use this? In this case, there’s $86 loss-to-lease, right? That’s no renovations. So if you’re going to renovate the unit and bring it up to a higher level, you take your loss-to-lease, you add your renovation bump to that, that gets you your total rent increase that you are putting into your underwriting. And ideally, your underwriting model should have these as two separate items, loss-to-lease and renovation increase, and you want to be able to toggle and adjust those independently.

David:
That’s a very good point. This goes down to the principle of levers in real estate, which I don’t know if anyone else talks about but when you get into investing pretty significantly, you start to recognize. Like Andrew, you mentioned the four levers that make a property worth more. Cap rates going down might be the biggest lever of all. You can improve your net operating income to make the value of a property goes up.
But that pills in comparison to the power of cap rates significantly going down. It’s just a bigger lever that moves things more. I say the same thing with the BRRRR method. If you’re looking at ROI, you want to get a higher ROI. Well, you can improve your cash flow, that’s one way. But if you can decrease the amount of capital you put in the deal, that lever is way bigger and it makes your ROI skyrocket.
So the deeper you get into investing, the more you’re learning on where do I get the most bang for my buck? What lever do I want to pull on? The rehab bump versus loss-to-lease are both levers that make your rent go up. But loss-to-lease is the bigger lever that’s much easier to pull on. And you’d rather find properties that have that kind of opportunity. So there’s always going to be both, but this is ideal. You want it to be on the loss-to-lease side as opposed to having to manage an entire rehab to get the same result.

Andrew:
Yeah, again, it’s all risk reward. This loss-to-lease generally carries the lowest execution risk of any value add strategy.

David:
Love it. Okay, number three. What do you have for us?

Andrew:
All right. Let’s jump onto debt quotes. And I have another example here, and this is, again, this is real life. This is a debt quote that we received actually on a property that we are under contract to purchase. I did redact some of the specific information for the asset. But when you’re looking at debt quotes, what you don’t want to do is just get… Or I shouldn’t say you don’t want to do.
But in generally what we have found to yield the best results and the highest chance of you being able to perform and close on the deal is to work with a competent and trusted loan broker who will take all of the stuff that you’ve gathered on this property, package it together really well and put it out to multiple lenders to help hunt you down the best deal, right?
Now, you’re not going to do this, you’re not going to actually send this to a broker every time you kind of get interested in the deal. This is, I’d say a deep phase two where you’re actually going to send it to them. But I want to have an example to actually show people some of the key terms to watch out for.
But when you’re doing the, I’d say an initial phase two, you want to at least have, if you don’t feel like you already have a really good grasp of what current debt terms are, then you want to at least run the deal by a competent loan broker and say, “Hey, I’m looking at buying this for 5 million, I want to get a loan for 70% of the purchase price. And here’s the P&L and I think I can get rents up this much. Could you just give me a rough idea of what we might expect for loan options?” Right?
That’s what you want to do in the beginning. Because again, you don’t want to waste your time, but you definitely don’t want to waste anybody else’s time. You want your team members to know that if you send them something, odds are it’s going to go through and everyone’s going to get paid. So again, so the initial phase two is either you already have a sense of what your debt term’s going to be, or you do a quick email or phone call.
If you’ve done a phase two and now, oh, hey, this thing looks good and we’re negotiating an LOI, or we really want to strengthen our offer, that’s when you might have your loan broker send you what I’m about to go over. So you know once you get into it kind of what the terms are going to be. So if you look on the visual, and again, make sure you go to YouTube, BiggerPockets YouTube channel so you can actually see this.
You see three different options on here, and I’m not sure why it’s labeled 1, 2, 4, but it should be 1, 2, 3. So the first is an agency fixed rate, agency floating and then debt fund floating. So agency, that means Fannie Mae and Freddie Mac, which are your government sponsored agencies, debt fund, that’s kind of everybody else. That’s bridge lenders, life companies, actual debt fund, et cetera.
And we could do an entire episode on just structuring your debt properly. But the main things you’ll see here or the main things you’re going to want to take into consideration when you’re doing your underwriting is number one, the term, right? So if you look on this, you’ll see agency is 10 year and the debt fund is three year. Especially right now, I won’t say don’t do bridge because there are appropriate times to do that, but be very careful with loans that have short maturities, right?
Long term multifamily, I strongly believe is going to continue to do phenomenal. But what you don’t want to do get a loan that is completely due in two years or three years and you have no other option other than refinancing or selling. Because what if the debt markets aren’t favorable at that time? Right? You always want to give yourself a little bit of exit.

David:
So what you’re saying is that the shorter that the loan term period is, the less time you have to get things squared away where you’re safe and the less things are able to go wrong before you get hurt?

Andrew:
Exactly. The longer the loan term, the more flexibility you have to adapt to and overcome any adverse scenarios that pop up.

David:
In general, it’s a safety feature to have a longer term loan. And I think one of the mistakes that newer people make is they always assume, “Well, everything’s going to go right and on that timetable, this is where we are.” And that is never the case. Nothing ever goes right.

Andrew:
Yeah. You will never, ever exactly hit a proforma. You will always be a little below or hopefully a lot above, but you will never, ever exactly hit it.

David:
Well, the reason that you come out ahead a lot of times is give yourself this runway. All of your assumptions are always negative. You’re like, “Well, this is going to go wrong and this is going to go wrong and this is going… And if all that goes wrong, I’m still okay under these circumstances.” I think when the market gets hotter, it gets harder to stick to that sort of a discipline approach that we take when we’re buying.

Andrew:
Yeah. I’ve definitely missed a lot of good deals over the years because of that, but I also sleep well. So to me, it’s an acceptable trade off.

David:
Nice.

Andrew:
So the next big thing you’re looking for is loan amount. Different lender, size things in different ways, but you want to know, am I… And so on this particular deal, they were giving us a range of, okay, with agency, you’re going to get anywhere between 13.7 and 13.9 million.

David:
Can you define what agency debt is briefly?

Andrew:
Yeah. That’s the government sponsored agencies, Freddie Mac and Fannie Mae.

David:
Fannie Mae, there you.

Andrew:
Which are fantastic commercial lenders. In fact, they kept the market alive in March of 2020 when COVID shutdown down all the bridge lenders.

David:
I’m glad you say that because we rarely ever say anything positive about the government. But that doesn’t mean that nothing positive ever happens, we just tend to not give credit to that.

Andrew:
And it’s more fun and easier to complain, right?

David:
That’s exactly right.

Andrew:
Than it is to give credit. But no, yeah. Well, that’s the thing. So bridge loans are great, but especially since you brought it up, that is another risk, right? This is going to sound negative, but I love bridge lenders, we do use them occasionally. But bridge lenders are like roaches when you flip on the kitchen light at night, they scatter as soon as danger arises, right?
So you look back at 2008, you could not get a bridge loan anywhere. March of 2020, bridge lenders, every single one of them left the market. If you were going to get debt, it was going to be Fannie or Freddy, that was basically it. So they tend to come and go. And what you want to be careful of, okay, I’m going to get this great bridge loan or I’m going to refinance into one and if something happens like March of 2020 or 2008, those bridge loans may not be there.
So again, just something to be aware of, that’s in the additional risk. So I should think of a better analogy, because I don’t like to call our bridge lenders roaches because they’re great partners. But this is the idea of scattering into their…

David:
They’re fair weather friends, so it’d be a great way to say.

Andrew:
There you go. Fair weather friends. There you go, there you go, there you go. So again, and then if anyone who’s on YouTube, you’re going to see there’s probably about 15 terms on here. So we’ll hit the really high ones or most important ones. So the next one is implied rate. And basically what that is saying is what all the lenders do is they take some kind of index, might be the 10 year treasury might be SOFR, it used to be LIBOR.
And they’re going to add what’s called a spread on top of that so it might be 2% or they’re going to have a number. And they’re going to say, “Well, okay, the interest rate that we’re implying you’re going to get is X,” right? So if we look at this, it says, “Okay, fixed agency is between 3.25 and 3.35. If we go floating rate agency, which means the rate can go up and down as the market interest rates go up and down, because that protects them from getting locked into a low interest rate loan, they will give you a lower interest rate to start so that’s between 2.8 and 2.9.
And then the debt fund is 3, to 3.6. So you can see, depending on which route you go significantly affects the interest rate. So that’s something you’re going to want to know what those rates are. The next one is max as is loan to value. This is one of the downsides of agency right now. If you look on here, the agencies are only going to give us 63% of the loan to value.
So if you’re buying a $10 million deal, they’re only going to give you a loan for 6.3 million. Whereas the bridge lenders are willing to give 75% on a 10 million and deal 7.5 million. In today’s highly competitive market where everyone’s fighting to get the returns that are needed, that extra 12% leverage can be huge in whether or not your deal is appealing to investors or not or whether it hits a certain IRR. But just be aware higher leverage, generally speaking means higher risk.
So again, which route you go depends on your source of capital, your tolerance for risk and your business model. But these are all terms that you want to know. I have heard many horror stories of somebody assuming they were going to get 75% or 80, they get down close to closing and the lender comes back and says, “Oh, sorry, it’s actually 63 or 62,” right? You need to know that upfront because if you’re planning on 80 and you get 63, your deal just blew up. So you got to know this stuff in advance and properly underwrite it.
Another key one to help prevent that is to know what’s called your DSCR, that stands for debt service coverage ratio. So if your property makes $10,000 in net operating income a month and your mortgage payment is $10,000 a month, that means your ratio is 1, right? 10,000 divided by 10,000. You won’t get a loan on that from the agency. What they want to see is generally speaking is a minimum of 1.25.
And again, that changes based on market and property size. That’s the number you want to know. You want to ask your loan broker or whoever you’re working with, what is that ratio need to be? So if they say it’s 1.25 and you’re estimating your mortgage payment’s going to be 10,000, then that means your property needs to have a net operating income of 12,500. 12,500 divided by 10000, 1.25, right? That’s the number you need to know.

David:
Basically that means a lender’s looking to see, “Can you repay the debt we’re about to give you? Can you cover the debt service on this deal?”

Andrew:
Exactly. And they want to make sure you have a minimum of 25% cushion in case something goes wrong.

David:
Yeah. You want to know something crazy? In the residential space, there’s such a demand for lenders that want to be investing in there that a loan company can do a 0.8 debt service coverage ratio. And it’s a 30 year fixed rate loan. That’s how much money is floating around there in the residential world that needs to find a home, that they’re basically saying, “Hey, if the property brings in $8,000 a month, it’s going to cost you $10,000 to get this loan, we’ll still give it to you.”
Now that doesn’t mean that you should ever operate it where that is the case, but they’re looking at it saying, “Hey, they can make up the rest of it with their income.” So these standards are definitely… I’ve noticed they’re tighter in the commercial space, but that’s okay because nobody is buying commercial property assuming it’s not going to make money.
The reason you’re buying it is because it makes money. A lot of residential properties purchase for different reasons. You use it to vacation, you use it to live in, you can kind of make it work as an investment. But residential real estate was never intended to be income producing property like commercial property is.

Andrew:
Well, yeah. And yeah, geez, we could probably do, like I said, a whole podcast or a whole Q&A on this. But just keep it moving. I’m just going to kind of hit the next ones really quick. The next one you want to know is how many years of interest only, right? Is it three? Is it five? Is it 10? Most bridge loans are interest only for usually the full term so the first three years.
The next one is what’s the amortization schedule look like after its no longer interest only? So you mentioned residential loans are typically 30 years. Fannie Mae and Freddie Mac are often the same thing, 30 years. A lot of bridge loans don’t amortize. It just stays interest only. Some bank loans might be 20, 25 years.
So you need to know what the amortization looks like because it doesn’t sound like much. But the difference between a 25 year and a 30 year amortization can have a significant hit on your cash flow because you’re paying more principle. It builds equity so that’s good, but it’s not loose cash flow that you can use. Okay?

David:
So let’s clarify that very quickly. If we’re talking about an interest only loan, basically they’re going to… You’re only paying the interest on the money you borrowed, you’re not paying down any of the principle. So the downside is that if it’s interest only, you’re not building equity by paying the loan down, the upside is you’re actually keeping more money in your pocket. Is that a great way to summarize it or a good enough way?

Andrew:
Perfect. You got it.

David:
So it can make you… This is why I want to highlight it. It can make you feel wealthier than you are when your cash flow is very high, but your loan isn’t being paid down, right? It’s usually better for you and less risky because cash flow in the bank can be used to get you out of tough times rather than paying the loan down if you’re disciplined with your money. And that’s why I want to bring this up, is everyone’s always excited about interest only loans, but it can create this false sense of security that you have more wealth than you actually do because that balloon payment is still building and you’re not creating equity as you’re paying down the loan.

Andrew:
Yep, exactly. If you save it, it’s an advantage. If you spend it, might not be the case.

David:
And the reason most of these loans are structured with interest only first is they’re trying to give you that cushion, right? To build up your reserves, to handle things that could go wrong that you didn’t foresee. They’re making it easier for you and they’re kind of like training wheels for the first little bit. And then after the three or five years, whatever it is, that’s when the amortization schedule kicks in and your payment goes up because you’re also paying down the principle.

Andrew:
Yeah. And also, especially if you’re doing value add, they know that yeah, cash flow might not maximize until three years down the road. So another huge one is prepayment penalty. And this has caught a lot of very experienced operators off guard the last five years. Because we all thought rates were going to go up and they never did, they went down.
Prepayment penalty means if you buy a house, you can pay off your mortgage basically anytime you want, right? David, I mean six months, 12 months doesn’t matter. And you just pay it off, you’re done. In the commercial world, the lenders say, well, they’re taking that loan, they’re selling it on the secondary market and they’re promising investors that those investors are going to get a return.
So if you want to pay off your loan early, Fannie or Freddy will say, “Okay, Mr. Greene, you can pay off your loan early. But by the way, we promised our investors a certain yield so you have to pay us all that extra interest we are no longer going to receive so that we can keep our investors happy.” And that’s an oversimplification. It doesn’t quite work that way, it really is nasty stuff, all these symbols that I haven’t seen since my advanced engineering classes.
The idea of it is if you pay off that loan early, you’re going to have a large fee or penalty that you are going to have to pay. So if you’re going to sell the property in three years, don’t get 10 year fixed debt because you’re going to have a huge prepayment penalty. They also call it yield maintenance.

David:
There’s always fancy words to describe very simple things when you’re dealing with multifamily. You and I should make an article, right? Like yield maintenance, Dutch interest, even agency debt sounds much cooler than Fannie Mae loan. Loss-to-lease is a cool thing to say. There’s a lot of it. When you get into this space, there’s definitely words that get thrown around and you’re like, “What does that mean?” Even cap rate like, “Oh, that’s just the return you get if you didn’t take debt.”

Andrew:
Yeah, if you bought it for cash. So the other two things are, what kind of lender fees are you going to have? Is the broker going to charge you a point? Is the lender going to charge you a point? Is there an exit fee? Most bridge loans while they don’t have prepayment penalty, they will have an exit fee. Meaning like when you repay it off or refinance, oh, we’re going to charge you a point on the back end, right? Or a half a point or something like that.
Again, nothing wrong with it. You just need to be aware of it and make sure that you underwrite for it. All right, next one is insurance quote. Don’t have a visual on this just because it gets pretty dense, but we’re just going to touch on a couple of things. Number one, never ever, ever use the seller’s number for insurance, right?
I can’t tell you how many times we find sellers that are either underinsured or improperly insured or their brother’s sister’s cousin has given them a discount that you’re not going to get. There’s all kinds of reasons not to use the seller’s number. Another reason is a lot of times you’ll come across where situation where someone is ensuring based on ACV, which stands for actual cash value. You want to always ensure for replacement value.
I made this mistake in my first deal, fortunately it worked out okay because we didn’t have any claims. But if you have replacement value, it’s going to cost you more upfront because what the insurance company’s going to do is they’re going to say, “Okay, if your building burns down, it’s going to cost a hundred dollars a square foot for us to rebuild it.” All right?
And if your building does burn down, basically that’s how much they’ll pay you. Again, we’re simplifying. If you do actual cash value saying, “Well, geez I can cut my premiums in half if I go for actual cash value.” Then what the insurance company’s going to do when you’re building burns down is they’re going to come in and say, “Well, yeah, you know what? This was built in the ’80s and the roof was 10 years old and this was five years old.”
So they’re going to apply depreciation to it and they’re going to say, “Well, the actual cash value of this is 50%. So here, your $5 million building, here’s 2.5 million, good luck.” Now you got to come up with the extra 2.5. So do not fall for the temptation of actual cash value insurance policies. And most cases, a lender will not let you do that. But if you’re buying a property for cash or you’re doing some kind of non-traditional debt structure, don’t fall for the trap of, “Cool, I can save a little bit on my premiums.” Because the minute you have a loss, that will come back to bite you big time.

David:
Well by calling it cash value, that’s misleading.

Andrew:
It is.

David:
Oh, I’m going to get the cash, right?

Andrew:
Yeah, that’s why I did it the first time. Like, “Wait, my premiums are half and it’s cash value?” I’m like, “Okay, cool.” And then a little bit down the road, I figured out what that actually meant. Again, this was 10 years ago, we know this stuff now. I said, “Oh, you know what? Let’s go ahead and make this replacement value, thank you.” And again, I got my one year of premium savings and considered myself lucky and moved on, never did that again.

David:
It’s one of those things that in multifamily, there’s big words that can be used that can be misleading. I’ve said this before. I have a general rule that if anybody says finance, instead of finance, I have to look very closely at everything they say because I assume they’re going to try to pull the wool over my eyes. So don’t be that person at the cocktail party that tries to sound smart by saying finance. We all know what it’s actually referring to.

Andrew:
So we’ll speed through a handful of these other things. So they’re a little more self-explanatory. The two main things you were going to need to get an insurance quote are the total rentable square footage and the annual revenue, right? Those are the two main you’re going to get. And you send that to your insurance broker, he should be able to give you a good rough ballpark idea of what that’s going to be.
Some other things you’re going to want to know, the next biggest thing is is there a history of claims? Right? If they’ve got three other insurance claims, that’s called a loss run, which is the history of losses, your rates are going to be higher. Because the insurers, understandably, they’re going to be nervous about that at building.
You also want to find out, have there been any shootings or assaults? Right? So if you go on Google Maps, grab the little yellow man, drop him on the property and he runs away, you should run away too. Because what that means is if there’s been shootings or assaults or any kind of violent crime, you’re going to have an extremely difficult time getting insurance in the first place.
If you do, you’re going to pay more for it and they’re probably going to exclude incidents of violence, which means if someone gets shot in your property, it’s not covered by your insurance company and they go to sue you for 10 million because the shooting was of course your fault as the landlord, the insurance company’s going to say, “Well, good luck, David, that one’s on you. We excluded that.”
That’s part of your screening too, or hopefully you’ve already screened for this and you’re not looking at a property with shootings, but again, you’re going to really, at this point, you want to make absolutely certain. Now some other questions. Does the property have aluminum wiring if it was built especially ’60s or ’70s?
Is it sprinklered? That doesn’t mean it has nice irrigation for the landscaping. That means does it have those little sprinkler heads inside the units? And is it in a flood zone or not? Flood zone is a completely separate policy. And again, if you go back to our screening, we don’t buy in flood zones for a host of reasons. Doesn’t mean you can’t, that’s a business decision for us, but we don’t. And here’s the tip David, what do you think is one thing that flood insurance does not cover flooding from in the commercial world?

David:
Maybe your own fire sprinklers when they go on?

Andrew:
Actually we’ve had that happen, that’s covered. Rain. Flood insurance doesn’t cover flooding from rain. And you say, “Well, okay, where else would flooding come from?”

David:
A dam breaking [crosstalk 00:48:10].

Andrew:
Yeah. And here’s the thing. So we learned this a few years ago, fortunately, not the hard way, just by asking enough questions. So when you’re getting a flood… So what flood insurance covers, it covers flooding from a body of water, the lake overflows, the river overflows, the ocean comes in on storm surge with a hurricane.
If it just rains 12 inches and the water piles up in your parking lot because it can’t get away fast enough and floods units, that often does not count and often will not be covered. Most cases you have to specifically get that written into the policy that that is covered. And that saved our butts this year. We had a property in Florida we bought, we specifically made sure that was written in there.
One month after we closed on it, tropical storm came through, 17 inches of water in the parking lot because of rain not tied to a body of water. If we hadn’t had that clause inserted into the insurance, again, not in the flood zone, it’s not in a flood zone, it just rained too much, then we would’ve been out of luck some big bucks. So that’s a really big one. All right, so moving on to property taxes.

David:
Number five, property taxes.

Andrew:
Yes, number five. This one’s absolutely critical. This is another one where sellers and occasionally some brokers will try to get this past newbies and say, “Oh taxes are really low.” Especially in again, in markets that we’re seeing now where prices have been trending up significantly that property taxes are lagging, right? And this is something that is very unique to each county and state.
So we’re going to go over some general processes for estimating property taxes, but you’ve got to dig in and find out how your local municipality handles this. Everyone is different. So I’m going to go ahead and pull up an actual tax statement to show this. But basically the gist of it is you want to go to your county assessor’s website, download the current statement, right? And then use that to determine how and when they’re calculating reassessments and then estimate your taxes, future taxes based on your purchase price and how they’re doing that.
So I’m going to go ahead and pull up, this is an actual property tax bill. This is from the Valdosta area or so the Lowndes County in Georgia. And what you’re going to see here in this area, they do a fair market value. So they estimate a value for the land, value of the buildings. They add that together and then they use that value to determine the taxes. It’s not that simple though. For some reason, nobody’s been able to explain this to me.
And if a listener hears this and knows the answer, I’d love to reach out and let me know. They don’t just work from that fair market value. They take that fair market value, they multiply it by 40%, then they take what’s called a millage rate. And a millage rate is again, just another one of those fancy terms for a number that they’re multiplying by to come up with whatever number they want, right?
So there’s two levers that the municipalities pull to change your taxes. One is the value, two is the millage rate. So what they’ll do in this county is they take your fair market value, they multiply it by 40% because I think it’s… I guess it’s fun. Then they multiply that new value by the millage rate and that gives you your taxes.
So in this example, again, go to YouTube, I’ve highlighted these numbers in yellow so it’s a little bit easier to see. The fair market value for this parcel was 2,476,000. Multiply that by 40%, the taxable value is 990,000. They have it broken out, there’s actually multiple millage rates, one for the KIPP school, one for parks and recreation, great show by the way, one for the industrial authority, whatever. And so the total millage rate is 34.77.
Again, would be… You would think, “Well, I will just multiply by 34.77, no millage rate, I think stands for mills, which means you divide by a thousand first.” So you take your tax bill value, multiply it by 0.034, that gets you your net tax on the bottom right highlighted in yellow of 34,439. You say, “Okay, that’s great, Andrew. That just tells me what today’s taxes are, right? So how do you use that?”
Now this tells you how they are currently calculating taxes. So you take that formula, fair market value times 40%, times the millage rate equals taxes. You go in and you put your purchase price in there, right? So now take your new purchase price times 40% to get your new tax bill value times the millage rate equals your future taxes.
Now, what that does is that’s actually telling you your absolute worst case scenario. That’s telling you if the county comes in, says, “You bought it for this, we’re assessing you for that same price.” In most cases, that doesn’t actually happen. What we do is we take our purchase price, cut it to 80% and then put that number into this equation, right?
And again, there’s a lot of other factors. Some areas do this every five years, some areas do it as soon as you buy it. It’s different by state by county. But the gist of it is go pull a tax statement, number one, understand how they’re calculating it and then use their method of calculating with your new purchase price to figure out what your future taxes are going to be. And in many cases, yes, your taxes may double or triple when you get reassessed. And if you don’t factor that in, your deal just blew up two years down the road.

David:
Very good. And if this isn’t making sense because you’re listening on the podcast, check it out on YouTube, there’s a visual aid. You can see exactly what Andrew’s walking through. It actually makes a lot more sense when you can look and see. It looks like the millage rate is basically how the county is splitting up the property tax amongst the different municipalities or organizations that need the money.

Andrew:
Yeah. And generally speaking, you don’t need to worry about how they’re splitting it up, you’re just looking for the total. I did highlight parks and rec on there just as an example, but really all you care about is the total. So again-

David:
Is the total.

Andrew:
Yeah. So you use that total number in your calculations and if you’re interested in where it’s going, that’s fine, but it doesn’t affect your underwriting.

David:
Okay, that wraps up property taxes. Moving on to number six.

Andrew:
Yeah. Number six is property manager’s opinion. And is exactly what it sounds like. You should already, at this point on your team have a well qualified property management company that is part of your team that you can get their opinion. And you’re not calling them on every deal that you look at, but this is phase two, you’re getting serious, right?
So what we do is anytime we’re at this point with a property, we will email our property management company and say, “Hey, are you familiar with this property and are you familiar with this submarket, and could you please give us your opinion?” Right? And typically what they’ll do is and once in a… I mean, in the beginning, before we knew our markets and before we were screening, they’d say, “No, run away, stay out of there. We don’t want to manage that, you don’t want to own it.”
But now with the screening, that doesn’t happen anymore. So many cases, they know the property… A good property management company’s going to know the property and they’re going to be able to give you feedback. And ideally, they’ll send someone over there to drive it for you and be like, “Oh yeah, we drove over there and it’s a great property and a great location, but there’s trash everywhere which that’s an opportunity, that’s really easy to fix.
Doesn’t look like anyone cares, they have no marketing, but it’s on this great high traffic corner and you could put a playground and a dog park. If you added some landscaping based on… And by the way, we manage a property quarter mile down the street that’s getting $400 more a month. This one, not quite nice so you could probably get 200.”
That’s the kind of feedback you’re looking for, someone who’s already an expert in that market to give you feedback on the market and on that asset and give you their opinion of it. What you don’t do is you don’t send them a budget and say, “Can we make this happen?” Because you don’t want taint their feedback. You want them to come back to you with a blank slate.
And again, if you’re screening right, most of the time, that should be at least somewhat positive. Every once in a while you might miss something. But that’s exactly, is you want a property manager’s opinion of the asset. And then once they do that, you might go back to them and say, “Well, geez I’m planning on… My loss-to-lease says I can get $125 rent increases. Do you guys think we can do that?”
And they’ll either confirm it or say, “Nah, it might be 80 or not. Geez, you can get 150, no problem.” Right? So that’s exactly what it is. You want to get a qualified property manager’s opinion of the asset, the location, the submarket and do they want to manage that for you?

David:
Yeah and be careful that you don’t do what you mentioned when you start to fudge things on a spreadsheet to make it work. Sometimes you feed them the information you want them to give back and they of course, want the revenue that’s going to come from managing it. So they regurgitate that back to you and now you’ve tricked yourself into thinking that they are capable of doing it.

Andrew:
Exactly. Don’t feed them anything. Just blank slate ask them in their opinion.

David:
Very good. Okay, number seven.

Andrew:
Yeah, renovation budget. So if you remember from the phase one underwriting, we basically just did kind of a quick guess like, “Yeah, I think we can spend 8,000 a unit renovating this, and we’ll do 200 grand on the outside,” or whatever the number is, right? Because the broker said you can spend this much and it’ll be great so you do that on the first shot.
Page two, ideally somebody on your team, either you or the property manager has toured this property and you’ve walked through and you’ve identified things like… And again, this is an example from an actual property that we purchased. We’ve walked through and we’ve said, “Okay, well, we’re going to spend… And we don’t have time to go into the details of how we came up with this, but we’re going to spend 600,000 on renovating interiors.
And let’s see, we need to do about 25,000 in landscaping upgrades, parking lot needs to be resealed and restripped. We’re estimating that at 63,000. New signage, 31,000, fencing, 35.” So basically if you go on YouTube and you look at this, what we’ve done in phase two is rather than just a guess of eh, a few hundred grand inside and a few hundred grand outside, now it’s really coming down to it.
And again, we’re just underwriting, we’re not under contract. So we’re not having contractors go out and give us bids. We are leaning either on a combination of our own knowledge or if you don’t have that knowledge yet, go to the property managers and say, “Hey I’ve looked at pictures, I’ve toured this. I think these are the eight projects that we need to do. What would be your range of how much this would cost?
How much should I plan for redoing the parking lot? How much should I plan for putting in a nice, pretty monument sign?” Right? All of those things. So phase one, you’re just throwing in some high level numbers. Phase two, you’re breaking it down by project, right? So again, these aren’t hard bids, they’re just getting a lot more granular so that you aren’t going to…
Because you don’t want to underestimate and run short, but you also don’t want to overestimate and lose the deal that otherwise could have worked, right? And two other things I’d really want to highlight on here. You look at the bottom, you’ll see contingency 126,000 and long term CapEx reserve. Two very important things that I often see people leave off. If things go great, you getaway with it. If they don’t, you’re going to be in trouble.
Contingency is exactly what it sounds. That is, oh geez. You know what? Appliances just… Cost of appliances just went up 10%. It’s going to cost me more, right? Or just found a bunch of windows that are cracked and fogged, we got to replace them. Well, that’s not cheap. It’s just adding in some room for finding stuff that goes wrong. Or you might discover, “Well, geez, if we do this additional thing, we can bump rents even further.”
You want to have brought the money in up front to be able to do that and maximize the value of your investment. The second is long term CapEx reserve. For us, it’s just the number we’re comfortable with. It might be different for you. We just do a thousand a unit, right? Because we know we’re typically going to hold for five years. Things happen.
Maybe the roof gets damaged and you have a $200,000 deductible on your insurance policy. Well guess what? That’s either coming out of your pocket from your investors, which you never ever want to have to ask for, or your term reserve that you started this out with in the first place.
So that’s what that long term CapEx reserve is, something happens year three or four or five, or if you’re holding long term, maybe even year 10 so that when that comes up, you’re like, “No problem. I got this.” Your investment’s safe, your investors are good. That’s an absolute key line item. But yeah, lots more we could jump into but I know we’ve been talking for a bit, so that’s kind of the gist of what you’re doing phase two renovating or renovation budget.

David:
And there’s almost always going to be a renovation budget of some sort, because you’re usually looking to buy something that has meat on the bone. And if there’s meat on the bone, then there’s work you’re going to have to do to get there. So this is something that I know a lot of people have questions about, how do I know what the rehab’s going to cost? It’s kind of something you got to look at a lot, speak with different contractors, get a feel for a baseline of what that’s going to look like. But you definitely want to be comfortable with it because anytime you’re buying an asset of this size, there’s going to be some kind of renovation that needs to happen.

Andrew:
Yeah, absolutely. And I said there’s two types. There’s I would say required renovation, like deferred maintenance and then there’s opportunistic, right? Like, “Hey, if we do this, we can attract better quality residents and bump the rents.”

David:
Right, there you go.

Andrew:
And then those are two categories, yep. So all right the final one.

David:
Number eight.

Andrew:
Yes, number eight for today, final one for today is follow up on P&L items on the T12, which stands for trailing 12. That’s a profit and loss statement that is broken that shows you an entire year snapshot by month, right? So it’ll show the income and the expenses for each month, 12 months lined up in columns right next to each other.
Property P&Ls are like fingerprints, snowflakes and penguin mating calls, right? No two are the same. You’ll see stuff from handwritten on pieces of paper to beautiful Yardi printouts with every single account perfectly lined up and everything in between. And you will see stuff on P&Ls that’s sketchier than a photo of Ozzy Osbourne at church, right? And this is where phase two, you ask questions about that kind of stuff.
And I think we’ll… We didn’t want to do this on YouTube because those 12 month P&Ls are so dense, but we will provide one in the show notes for everyone to go look at after the fact. But some examples of things you’re looking for is anything that’s unusually high or unusually low, right? If you expect insurance to be $300 a unit and it’s 450 a unit, that’s a red flag. You want to find out why.
Maybe they just have a bad insurance broker or maybe they’ve had three fires and a shooting, right? And again, and some of this stuff gets redundant, but that’s on purpose, right? You want redundancy so that if something important gets missed on one step, you’ll catch it on another. So missing payments. I can’t tell you how many times we see the landscaping bill suddenly doesn’t get paid for two months.
Well, where did that go? What happened? Why? Or the utilities go way up and go way down. Does that mean they’re having underground water leaks all the time? What’s going on there? Often times you’ll see strange accounts, large credits are another big one. You’ll look at, “Oh wow, the repairs and maintenance on this property is really good. It must be a great property.”
But then you look closely at the P&L and wait a second, there’s a $30,000 credit. Where did that come from? Because if you just look at the end number, it’s going to be wrong. Because they’ve reduced that expense by 30,000. And there’s lots of legitimate reasons for that, but this is where you go ask, right? You’re looking for opportunities and traps.
So again, if their insurance is 450 a unit because they maybe have a, not a great loan broker and you can get it for 350 legitimately, that’s an opportunity. If it’s 450 because they had three shootings, that could be a trap especially if you assumed you could get 350 in phase one.
These are the things you’re asking questions for. Other things that you might run across are things like HOA fees. We’ve actually owned an apartment complex that had HOA fees. It’s not a problem as long as you underwrote for it in the first place, right?
Usually, you’re not going to assume that, you’re not going to automatically underwrite for it because most don’t have it. But if you’re on the hook for $20,000 a year for HOA fees and you don’t put that in your underwriting, all of a sudden you’re behind the eight ball when it comes to hitting your proforma. We actually saw a T12 one time that was a T13, meaning they had 13 months of data in 12 months, which means all the income and expense numbers were inflated.

David:
Artificially inflated, yeah.

Andrew:
Yeah, artificially inflated. I don’t know if it was intentional or not, but it was not accurate. Stuff like cell phone tower income.

David:
And I should probably say when we say T12, we’re talking about the trailing 12 months of profit and loss, right?

Andrew:
Yeah. And so they had for 13 months on there for some reason. You’ll see stuff like cell phone tower income, billboard income, people leasing out units corporately, things like that, all good stuff, but yeah, okay, well, does that transfer to you? Does that stay with you? And does that terminate? When does that lease expire?
Again, things to look into because we have a property with a billboard, it’s great income. But we had to make sure that when we bought the property, that that transferred to us, right? We found one, we had a contra account on it. And then I’m like, “What the heck is a contra account?” Basically, my understanding of the accounting definition in English definition, a contra account is an account that you use to adjust another account up or down to make it look like how you want to make it look, right?
So need to say that was something that we dug deeply into like, “Okay, why are you guys just putting in… Why do you have a contra account and why are you trying to use it to adjust these other accounts?” Right? It was definitely a red flag. And actually we never got a clear explanation and we didn’t end up buying that property.
So again, those are just some examples of the things that we’ve come across and you could probably list a hundred, I’m sure everyone’s listening, is like, “Oh my gosh, you should have seen this thing on here that I found one time.” But that’s what you’re doing. Anything weird or different on that P&L and phase two, you want to ask questions of either the broker or the seller to clarify what that is and find out is it an opportunity or is it a trap?

David:
Beautiful. Okay, that was really good. Like I promised everybody, you’re getting a masterclass in evaluating multifamily property. Can you give us a brief rundown, Andrew, of the eight steps in underwriting phase two?

Andrew:
Yeah. So underwriting phase two, the quick recap. Number one, rent increases. There’s two components of that market rent growth, we talked about last time and then this time we talked about renovation increases, bringing it up to market. Number two was loss-to-lease meaning, hey, you know what? The last five leases were signed for a hundred dollars more.
If I buy this, my research indicates that I should be able to at least get the remaining leases up to a hundred dollars. By eliminating that loss-to-lease, I effectively bring my rents up a hundred dollars so that can be a huge opportunity. Third one is debt quote. When you’re doing phase two, you’re getting serious about hopefully making an offer. You don’t want to just be guessing at your debt anymore because that’s one of the big levers.
You want to at least get a quick verbal or if you’re getting deeper into it, get an actual kind of like quote matrix like we showed where they’re saying, “Yeah, if you go this route, it’s this and if you go this route, it’s this.” Number four was insurance where again, you’re not having everyone go through the full process of getting an entire quote, but you’re going to give them the total square footage and the annual revenue at a minimum and say, “Hey, ballpark, what’s the cost? Is it 300 a unit? Is it 400 a unit?”
Number five is property taxes. You want to find out how does that municipality currently determine property taxes, and using that method after you buy the property, what does that mean for how much your reassessed taxes are going to be? That has a huge, huge impact on your P&L.

David:
That’s for all real estate. Don’t look at what a property taxes currently are, unless the values are going down, I suppose. When I bought my first property now that I think about it, it had sold for 565. I bought it two years later for 195. I paid property taxes in my import account up front on the higher value and I got a refund check.
But we haven’t seen that in a long time. It’s usually the other way where you’re going to get another check after closing that says, “Hey, you owe us more money.” So it doesn’t matter what the person is paying right now, it matters what the value’s going to be based on, which is usually your purchase price when you buy it.

Andrew:
Yep, exactly. Number six was the property manager opinion. Get someone who just knows that market inside and out and get their thoughts on it with… Don’t feed them. You’re hoping for good feedback and so it’s tempting to give them something to hand back to you, don’t do that. Just ask them blank slate.
Number seven is renovation budget. Again, you’re not having contractors go out there, you’re just trying to break it down and get a little more granular and say, “Okay, well here’s the list of projects and here’s how much I think those are going to be and that total’s up to this.” Because best as possible you don’t want to overestimate, but you also definitely don’t want to underestimate.
And the final one is this falling up on P&L items that either don’t make sense or that could be an opportunity or could be a trap. So those are the eight things that we covered and there’s lots of other little sub pieces and different parts that you could dive into. But those are kind of eight key ones that are part of phase two. And determining is this cream or is this a turd? And if it’s hopefully cream, then that’s where you decide, “Okay, am I going to put an offer on this?” And then get into, “Well, how do I write that offer? How do I decide the terms? What’s going to be appealing?” And go from there.

David:
Well, thank you. I actually get to brag a little bit. You made be very proud. Everyone, this is why this is my multifamily partner right here because he’s this good. So thank you for sharing how you put this system together. I’m happy I got to play a small role in encouraging you to leverage some of this stuff out to these other people because that’s grown into this incredibly detailed, very, very accurate way of analyzing properties that is leading into success. Do you mind sharing a little bit about what you’re up to right now? What properties are you looking at? What does your week look like and what success are you having?

Andrew:
Like I said, with this, going back to the loss-to-lease, that’s been created by the last year and a half, two years, there’s a lot of opportunity out there. We’re under contract on a couple hundred units right now and then we actually just got a offer accepted.
We’re not fully under contract so I don’t want to give out any specifics. But we got an offer accepted in a market where it’s one of the strongest, fastest growing markets in the country. We already own multiple properties in that market so we know it well. So we’re super excited about that one. And that is actually going to be our first ever 506(c). Well, I think we’ve done 16 or 17 506(b)s where we never talk about it basically you have to already know us just to find out about it.
But this one is going to be 506(c) and we’re doing that one with you, David. If that property, if we do get it fully under contract is something that you might be interested in, it’s investwithdavidgreene.com. Right David?

David:
Yeah. If they go to investwithdavidgreene.com, you can fill out a form that will basically end up putting us in touch with you where we can share more details about this deal if this is something you want to invest with Andrew and I on. Can you break down what 506(c) means?

Andrew:
That gets down to the SEC regulations. So 506(b) means if you’re raising money for a deal, you can’t solicit. And solicit basically means anything, right? You can’t talk about it on a podcast, you can’t post about on Facebook and LinkedIn. You have to have a preexisting relationship with anyone that’s investing. 506(c) means you are allowed to talk about it but anybody that says, “Hey, I want to invest,” has to be accredited and verify that they’re accredited. So that’s the difference. It’s just a different set of regulations and rules that the SEC puts out for syndicating.

David:
Now, if you don’t know what that means, that’s okay, you could still go to that website, you could register. We will let you know if this deal would work for you and the status you’re in, or if a different situation with me would make more sense. But Andrew’s being a little bit humble here. He found this deal off market, it’s a great area. The property that we bought just before this one has exceeded everyone’s expect times 10. This is the best part about Andrew, is he’s always super conservative as underwriting. He’s like Eeyore when he underwrites but he’s like Tigger when he performs.

Andrew:
I love that, that’s great.

David:
It’s perfect, right? So he always under promises and over delivers and that’s why I partner with him. So if you would like to partner with us, please go there. Now the last stage in the entire underwriting system, we’ve gone through phase one, which is, would this work? Phase two, is this cream or is this a turd? Phase three would actually be when you send the letter of intent and you actually go through the process of putting it in contract, can you share Andrew if they want to learn more about what to do at the last phase, where can they go?

Andrew:
Yeah, go to davidgreenewebinar.com. And I think what we’re going to do is David and I are going to do a webinar on how you put together an LOI. So I say you’ve been through all these steps, it’s a lot of work. Fortunately, you found one that looks really good, you want to own it. And we’ll talk about what kind of terms do you put in the LOI? How do you determine what can you say, do you put in references? Do you not put in references?
What if your offer seems kind of low? Do you still do it? Do you not do it? How do you communicate that with a broker? How do you communicate with that the seller? We’ll go through and talk about crafting the best offer that gives you the highest chance of getting the deal, but at a minimum, gives you credibility and builds your reputation in the market.

David:
Now we know not everyone listening to this podcast is going to go buy a $50 million apartment complex, you might not even buy a $5 million one. But you do now have the information that you would need if you wanted to do it. So our goal here was to basically show you every step, phase one, phase two, and then a webinar where we can talk with you with more length basically and we can answer more questions and we can actually get out in a podcast about what to do when you want to write an LOI and how you put a property in contract.
I can personally vouch for Andrew. He’s a great dude, he’s super smart, he’s very good at investing, we’ve made a lot of money investing together. And I feel comfortable telling other people this is the person that I invest with because that means a lot to me. So I would highly encourage you to go there and register.
There’s other webinars too. I do other stuff on lending practices or short term rentals. There’s a lot of stuff where I try to get back to the BiggerPockets audience. So I highly recommend everybody listening to this to do that as well as if you would to invest with us, that’s a great place to start. Any last words you want to leave people with Andrew?

Andrew:
Yeah, I would just say I know that was… I guess hopefully everyone’s still awake and I know that was a bit dense. But I mean, that’s the reality of what underwriting even a 5 or a 500 unit property is. In order to do it right, you have to get it down and dirty into the weeds of these numbers and these P&Ls. And if you’re saying, “Oh my gosh, I could do this for 30 minutes, then I’d run away screaming,” go partner with somebody that loves it or hire somebody that loves it.
But in order to properly underwrite, this is the type of thing that you need to do. And yes, there’s other ways of doing it, there’s other ways of looking at the data, this is just what we have found to work exceptionally well for us. But as long as you use the principles that we talked about, then you should be able to hunt down some really good deals for yourself.

David:
That is wonderful. You reminded me of something. When I was first in the field training officer program as a police officer, I worked for an agency that covered five counties. So when we were training, they would drive us through every county and go to the main areas that they thought we would need to know in an emergency.
This is the hospitals in these areas. These are the local police departments that if you ever need backup or you’re trying to figure out like, “What can I do in emergency?” Here’s places that you can go. Here’s places where the county stores equipment that we might need in the case of a flood or something like that. And they knew that we would never remember all of these places that way.
It’s impossible to remember that much information. But the thing is, they also understood when I was trying to find that place three years down the road, I would remember little landmarks that I saw or I would spot the building and say, “That’s the one that I’m looking for.” It sits in the back of your head.
Now I couldn’t walk you through turn right here, turn left here, but when I got close, I recognized I’m on the right path. That’s what a podcast like this is. You are never going to remember all eight steps plus the four levers we talked about before, plus the six steps in phase one underwriting, you don’t need to. No one is going to learn it like that.
It’s getting the concepts in your head and as you take this journey, those will stick out like milestones. Just like when you’re in the woods on a hike and you’re not sure exactly where you are, but you remember a certain mountain peak or you remember a tree that’s in a certain place and it’s like, “Oh yeah, going the right way.” That’s what information like this functions.
So don’t beat yourself up if you’re listening to this and you’re thinking, “I’m an idiot, I don’t get it. I’m never going to understand this.” Andrew didn’t understand this when he was first putting this together, I don’t understand this stuff. It’s something you have to do over and over and over like everything else in life. So don’t beat yourself up.
Instead think if you thought that was interesting, that was fascinating, that’s a good thing. That’s your fire. Add wood to that fire, build that fire, pour into that fire, invest into that fire. Build up that desire to learn more and as you stick with it and you stay in this world long enough, this stuff will start to make sense and you’ll start to get confident.

Andrew:
Yeah, that was an excellent recap. This doesn’t come on the first… This was built and honed out of looking through literally thousands of deals and properties. It’s not something that I or anyone else starts off with.

David:
Well, I’m really glad that you shared that thousands of properties expertise and experience with us here today. And I hope people join us on our webinar where we can talk about it my more and consider investing with us and getting some experience and making some money in the process. Anything you want to say before we get out of here?

Andrew:
No. Like I said, in the beginning, I put the earbud in the right ear first and so far, that’s working. It’s been a good day and it’s good talking with you and hopefully we do it again here soon.

David:
How can people get in touch with you?

Andrew:
LinkedIn, that’s probably the only social media platform where I am somewhat active, and then our website vantagepointacquisitions.com. There’s a couple of different tabs on there. If you want to connect, fill out the little form and that comes to my inbox.

David:
All right, you can follow him there. You can follow me at Davidgreene24 on social media. I also have a brand new spanking and website up, Davidgreene24.com. And I will be, or maybe by the time this releases already have released a free text letter that kind of explains what I’m doing, what I’m up to, what kind of properties I’m buying, where I’ll be speaking and how we here at BiggerPockets can help you to grow in your own education to achieve your goals.
So please consider following me there. And if you like this episode, go back and make sure you listen to episode 571 where we break down phase one of this process. And then do you remember your other episodes you’re on Andrew? Was it 170?

Andrew:
Yeah, it was 170 and 279.

David:
So this is your fourth time on the podcast. That’s how good you are.

Andrew:
Wow, I guess that’s a pretty small group. I feel honored.

David:
Yeah, if you’re on the Mount Rushmore.

Andrew:
Well, thanks.

David:
I have a really funny meme that says the Canadian side of Mount Rushmore and it has a bunch of the butts of the president, says they’re sticking their head on the mountain from the reverse side.

Andrew:
Oh, that’s awesome. I love it.

David:
Oh, I also thought that was funny. All right, I’m going to let you get out of here. This is David Greene for the BiggerPockets Podcast signing off.

 

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Steps That Will Stop You From Getting Burnt on Multifamily Deals is written by The BiggerPockets Podcast for www.biggerpockets.com

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