Multifamily underwriting best practices

SilverTRD
Rank: Baboon | banana points 126

I wanted to reach out to the board here to get some input on how others (especially lenders) U/W multifamily deals. I work for a boutique capital markets brokerage and I'll copy how we u/w deals below. I'm told that these best practices match even our most conservative correspondent lenders.

These best practices apply to properties in the greater SF Bay Area and greater Los Angeles area that are 10 - 200 units. While I know that many of you do not primarily focus on this region please share your best practices anyways so I can compare.

Annual Expenses

RE Taxes - (1.15% - 1.25%) of purchase price if acquisition. If refi, look up tax bill in county website.

Insurance - (0.30 - 0.50 per sq. ft.) All else being equal, the older the property the higher the insurance.

Utilities - borrowers actual in prior year plus 3%. If not data, roughly $1,000 per unit. (gas, electric, water/sewer and trash).

Repair & Maintenance - u/w greater of prior years' actual + 3% or 750 per unit. (includes R&M, supplies, landscaping, etc.)

Management (Off-site) - (4% - 5%) of EGI.
Management (On-site) - (2%) CA state law required for buildings greater than 16 units.

General & Admin - u/w greater of prior years' actual + 3% or 150 per unit.

Capital Reserves - 250 per unit

Comments (20)

Feb 12, 2014

1. RE Tax - Is california a disclosure state?
2. On-site Management looks low, I see 3%
3. Off-site - Varies by firm, 5% Asset Management fee is high

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Feb 12, 2014

1) Yes CA is a disclosure state. I wasn't even familiar with a non disclosure state but I found that every state is a disclosure state except for the ones listed below.

Alaska
Idaho
Indiana
Kansas
Louisiana
Maine
Mississippi
Missouri
Montana
New Mexico
North Dakota
Texas
Utah
Wyoming

2 & 3. I find using a 5% AM fee over the top as well. Do you normally combine both mgmt fees and call it 6%?

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Feb 13, 2014
SilverTRD:

1) Yes CA is a disclosure state. I wasn't even familiar with a non disclosure state but I found that every state is a disclosure state except for the ones listed below.

Alaska

Idaho

Indiana

Kansas

Louisiana

Maine

Mississippi

Missouri

Montana

New Mexico

North Dakota

Texas

Utah

Wyoming

2 & 3. I find using a 5% AM fee over the top as well. Do you normally combine both mgmt fees and call it 6%?

That's good to know, I should probably save this list somewhere b/c I waste way too much time underwriting property taxes. Its difficult because the assessment ratios, mill rates, reassessment years, all vary dramatically state by state. If any professionals intend to use this list above, I would proceed with caution b/c we have bought an asset in Indiana and the assessors did find the purchase price despite our efforts to hide it (I'd recommend entity level purchase here, if you can pull it off).

I've never seen anyone combine a property management and Asset Management fee. Most companies consider asset management a corporate G&A (overhead) where as an property management fee is a property level expense.

Feb 13, 2014

replacement reserve usually depends on how old the building is and the quality of the previous owner - a public reit owner is probably gonna take better care of a building than a private one.

Feb 13, 2014

Regarding RE Taxes, for a refi I look up historical bills as you mentioned; however, for an acquisition I look into the specific jurisdiction's method of assessment and calculate the taxes myself based on the purchase price, etc. This is typically how you will see it done in the appraisal, so we do our best to be thorough to avoid questions later from the lender.

Insurance: we work with a lot of experienced borrower's who simply get an insurance quote from their agent and that is the value we underwrite too.

All operating expenses we pick through line by line and sometimes make an adjustment but a 3% escalation is pretty common.

This all depends of course on what type of lender you are shopping it to. For GSE's they all have their own underwriting standards, so everything changes.

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Feb 13, 2014

Agreed with tsingle on the RE taxes. Have a note card in my desk with all the local counties and state property tax rates.

We also try and break out individual utility/repair&maintenance expenses as much as possible. Main one being snow removal. If you're just doing a general 3% increase and the year before was a tame or extreme winter...

Feb 14, 2014

Right, it is important to review the historical trend for each account on the past statements. We tend to look at the past three years in search of any anomalies and make adjustments when necessary. Snow removal is a great example, but there can be oddities with any line item. Another common one is legal where you may come across a large expense one month due to an uncommon lawsuit. This expense should not be trended at 3% as it is not reoccurring.

Put another way:
#1 Multifamily Underwriting Best Practice - Attention to Detail

Feb 17, 2014
tsingle:

We tend to look at the past three years in search of any anomalies and make adjustments when necessary. Snow removal is a great example, but there can be oddities with any line item.

This is good. I wish more people would do this. On the revenue side, ignoring everything except T3 seems pretty common in multifamily. Ridiculous.

Feb 17, 2014

We typically use a current rent roll for GPR. Vacancy depends on a myriad of factors, a historical average, current RR, market, etc. Other income we usually use T12 or contracted amounts is possible (cable, trash, etc.). The only item above the EGI line we use T3 for is concessions, and even then only 50% of the time. Although, if you are talking FMCC, their main test on the revenue side is based on T3 collections, so I suppose it is lender specific.

I can't believe someone would only look at T3. I can understand not going back 3 years if one is lazy, but it is completely asinine to not at least consider 12 months due to the cyclical nature of many expenses, and even revenue for many assets.

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Feb 18, 2014

I have been increasingly seeing T3 being used for revenue. I think its so bankers can give more credit to the properties. I do personally like T12 as you get a bigger picture.

Mar 19, 2014

Taxes: Competent lenders will look at taxes in CA on a refinance as greater of the millage rate * loan proceeds and the current bill trended up, typically by 3%. If the property gets foreclosed then taxes will be adjusted up based upon the loan amount as the purchase price.

The lender's basic UW is this - Rental Income T-3, Other Income T-12, Expenses T-12+3%. That works if it is a standard stabilized deal for the most part.

Mar 19, 2014

bump

Mar 19, 2014

I encourage you to take an Excel modeling course.

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Mar 19, 2014

If you are trying to sell a 20 property portfolio and can't give a rough estimate of debt capacity by using rates, amortization, and a minimum DSCR you're gonna have a bad time.

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Mar 19, 2014

As you may or may not know, a 20 property portfolio has a bunch of moving pieces. Modeling to reflect this isnt the most straight forward. Seller may want to separate certain assets and sell individually while bundling others vs selling portfolio as a whole at a discount. Then comes the question of valuing some properties that have significant value add/ development potential with corresponding air rights etccc and modeling to reflect that. If it was summing up the total noi and assigning a cap rate to entire portfolio then i wouldn't have asked for advice. thank you though.

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Mar 19, 2014

Your post said you had three things, a rent roll, NOI and assigned cap rates. Nothing about air rights or parceling properties out of the portfolio. Once you have an in place and/or stabilized NOI, then sizing debt should be simple

Mar 19, 2014

You said debt potential... not value.

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Mar 19, 2014

Value each individual property based on the cap rate in their respective market and cash flow from ops. Use a comfortable LTV and bingo.

Mar 19, 2014

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