Fundamentals of Underwriting
Hi all,
Just starting out and I'm trying to understand underwriting on a deeper level than just punching numbers into a spreadsheet. For starters I would like to know what are good returns for value add multifamily but more importantly what makes those good returns. I would also appreciate any other advice and resources on underwriting.
Thanks
There's no right answer tbh. The goal is that you want to be correct in your assumptions as much as possible to get a clear picture of what the investment will end up doing in the next 5-10 years. Once you have the most accurate model you think is humanly possible, you can see the return metrics and if you are ok with the returns based on the risk you're taking on then it's a good deal, otherwise it isn't for you. Some funds are fine with taking on a value-add deal and getting a 10-12% IRR simply because they think it is a low-risk deal or because they are happy to just have positive growth. Then there are some funds that think anything less than 18-20% IRR isn't worth their time or too much risk.
Besides the internal IRR thresholds, firms also have to think about their equity sources and what are good enough returns for them. If you're syndicating deals with HNW instead of institutional they will have different risk appetites and IRR thresholds that they want to see in a deal. You might internally be happy with 12% IRR but if your LPs are only ok with 15%+ then you'll never get equity for deals (which is why some places do multiple models for internally v. LPs and lenders).
Finally, general market conditions. Right now most people are seeing double digit losses in the public equity markets so an upper middle class family that is seeing their portfolio drop 20% in stocks would be ecstatic to have a double-digit return and steady cash flows. But during times like the back half of 2020 and early 2021 when stocks were rebounding and soaring, you could take on less risk and get 3x returns on tech stocks with much more liquidity and shorter time horizon. People's expectations on investments fluctuate based on their alternative options and right now there aren't many better options than a cash flowing asset that can hit 12-15% returns.
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