Introduction & Thank You!
Real estate holdings are one of the best ways to grow the business’s net worth and its earnings, but it can be daunting to go about, both for beginners and seasoned investors. The Multi-Family property is one of the best asset classes in the real estate industry, owing to an overall undersupply in the market and a significant population growth rate. With this huge growth potential, investors have faced many potentially lucrative investment opportunities, and it can be especially difficult to determine the best options to choose. This book, therefore, offers a solution to this problem as it presents a well-tested, robust method of underwriting opportunities that individuals and potential investors may get to ensure that they make accurate value estimations. The book also contains a case study property that helps demonstrate the key investment principles. The case study presented will give a reliable approach to the various dealings and proposals that investors and clients may get in the future as they try to understand the underwriting world. Therefore, I hope every individual will take enough time to read the book keenly and pay close attention to the recommendations offered at the end of the presentation and the case study. Through the contents of this book, clients and investors could develop an in-depth understanding of the investment principles closely. The real estate industry is here to stay, and multi-Family development opportunities are key to a big share of the industry pie. Thank you for selecting this book, and here is a pleasant and fruitful ride through the multi-Family universe!
First things first
“Real Estate cannot be lost or stolen, nor can it be carried away. Purchased with common sense, paid for in full, and managed with reasonable care, it is about the safest investment in the world.” -Franklin D. Roosevelt
Welcome to Real Estate
“In the real estate business, you learn more about people and you learn more about community issues, you learn more about life, you learn more about the impact of government, probably than any other profession that I know of. ” -Johnny Isakson
Real estate is one of the most lucrative investments you can make for substantial and long-term returns. The returns are so much such that over three-quarters of all millionaires in the United States have holdings in this sector. Investors in real estate can either purchase existing properties or develop them, but it is the latter that holds promise for bigger and better margins over the ownership period and upon sale. It also comes with many risks, but if done well is worth the investment. Commercial real estate (CRE) has risen to prominence at the hands of a convenience that leads to a better return on investment.
There are several asset classes of CRE, and Multi-Family property is one of the most preferred. The Multi-Family property is largely attributed to the general ease of understanding, unlike other products like industrial, retail, and office properties that come with several complexities like long-term leases that discourage aspiring investors. Also, the US Multi-Family market is undersupplied, meaning the valuation of these holdings will continue to rise over the foreseeable future. The National Apartment Association reported in 2017 that the nation needed 4.6 million new apartments by 2030 to avoid a serious shortage (National Apartment Association, 2017).
Further, the association states that around 11.7 million existing apartments might need renovation over the same period (National Apartment Association, 2017). A supply-demand imbalance all over the country gives investors a lucrative opportunity in a relatively easy-to-understand asset class. If this has whetted your appetite, read on to find out about one of the best ways to go about multi-Family commercial real estate.
This book will introduce you to the essentials of real estate development with a special focus on the valuation process. We will also use a case study property to give a real-world example and application of the processes and ideas mentioned herein. The case study chosen for this book is a proposed multi-Family property in Brooksville, Florida, called Arden of Brooksville, consisting of 360 units.
The investment will involve providing funds for the ground-up development of a luxury living community providing Class a Multi-Family housing. As a potential multi-Family property investor, you will face many offers like this one, and you must have a robust valuation system. Valuation in real estate happens in the form of an underwriting process to help you determine a project’s real value upon completion and if it is worth investment. We will first look into underwriting before going into how to go about it in the multi-Family asset class.
Underwriting in Real Estate
” Underwriting, an odious but not illegal practice.” – John Grisham
Underwriting was first coined by a UK-based company called Lloyd’s of London. The insurance broker came up with this term in the 17th Century when it was looking for individuals to cover risky business undertakings like sea voyages. The investors would write text describing the endeavor and the amount of risk they were ready to assume in exchange for a specific return and wrote their name under the same. This scenario is what would come to be known as underwriting the risk. Underwriting performs an important role in various sectors of the financial world like insurance, lending, and investment, but it is especially important to real estate. To see how we first have to understand how it works and its relation to real estate.
Underwriting today is the process via which lenders determine a potential client’s creditworthiness. It is a crucial process that helps set prices for investment risk, set borrowing rates, and determine the insurance premium an individual will pay. Underwriting determines the accuracy and security of a given entity’s application and the risk of insuring or lending to them (Esajian, 2022). Therefore, underwriting is due diligence or fact-checking before assuming risk. Underwriters research a given application to determine its truthfulness and feel the applicant’s value. Real estate underwriters take the process further and determine whether a given property’s appraised value matches its sale value.
Real estate development projects often need funding in the form of loans, and underwriters analyze the request to determine how much risk the lender can take on. Often the underwriters are the lenders, so they must know how to proceed. Underwriters in real estate consider both the land/property and the borrower. Development companies or individuals seeking funding are mandated to appraise the property, and the underwriter uses the resultant findings to determine if the funds generated from the project are adequate to cover the loan. This process also ensures that other elements of the property are in check. The process often constitutes determining whether the property faces the risk of damage by natural disasters like earthquakes, natural fires, or floods and making sure only the applicant is one the title.
Underwriting Multi-Family development opportunities
“Obviously, there’s the temptation to sit back and smile,… But there’s so much at stake, we have to do our due diligence.” – Ralph Neas
Put in the simplest terms, underwriting a multi-Family development opportunity is gathering data on the property, coming up with assumptions about how the project is likely to do in the future, creating its projected cash flows, and assigning a valuation based on the resultant information. Different real estate markets have different conditions to consider when looking to underwrite a deal. However, specific patterns emerge in every underwriting that an investor can exploit to create a structure around the whole process, no matter where they operate. Before breaking down multi-Family underwriting into steps you can follow, it is crucial to understand the development process.
According to Justin (2021), multi-Family underwriting refers to gathering data on property, making key assumptions about the property, and creating projected cash flows on the property investment. In addition, the latter entails assigning a valuation to the property using the information available on the existing investment plan. In addition, Justin (2021) provides seven underwriting steps in multi-Family investment. The first step involves the determination of the revenue that the property would generate monthly using the current income items expected from the property constructed.
The second process of multi-Family underwriting involves determining the expenses, which would be evaluated using the ordinary and recurring expenditures on a monthly and yearly basis. When the expenses are considered, the underwriter will understand the different growth level expectations and how each item affects the general cash flows from the investment plan. The third steps of the multi-Family underwriting process include building the construction budget, which would be used to create the growth value using the renovation of the key areas in the investment project. An investor should therefore come up with a real estate financial plan which would offer a breakdown of all the relevant costs and their projections at the end of each period.
In the fourth step of the process, the underwriter should make various growth assumptions, including engaging the items that offer market growth values and can affect the value generation of the investment plan. In this step, the various database can be used to ensure that the project performs to the expectation of the investors. In step five of the underwriting, investors should make projections on their rental premiums to enable them to upgrade their common areas and adjust accordingly to produce the best returns.
The next step involves an underwriter making the key debt assumptions on the property which would, at the end of the process, constitute significant returns and valuations. Here, the underwriter should ensure that they make accurate assumptions of the total debt of the multi-Family property owners and the likely interest to be charged on loan. Lastly, the Multi-Family underwriter should solve the valuation of the project using the projected cash inflows and outflows to ensure that the specific goals of the investment plan are achieved.
In valuing the financial projections, an underwriter should use three basic metrics: the internal rate of return, equality multiplicity, and the cash-on-cash basis multiplier. These measurements would assist the underwriter in establishing the key financial weaknesses and strengths of the multi-Family project, which would therefore be adjusted accordingly by the investors in the bests time possible.
Developing real estate occurs in three main phases: pre-development, construction, and post-development. These stages occur in order, and understanding them will help you conduct a better-informed underwriting (Gower, 2019). The pre-development phase includes a thorough analysis of the property. This phase also includes critically analyzing how value can be added to the property, which is where market analysis comes in. The project is usually developed according to the demands of the market where it is located.
Different markets will need different approaches. For example, some developers will build properties in expensive markets to get more stable, albeit with narrower margins. Others may develop in secondary and tertiary areas, accepting increased risk for high cap rates and returns. All the rest fall in between, so you should always have an in-depth understanding of why a particular developer chose the specific location. You should then seek to understand why a developer chose the specific property by vetting it. The vetting process includes looking at zoning, construction design, local government policies, tenant negotiations, and cost analysis and redesigns; more on this later.
The construction phase is the most expensive part of the process that can especially become costly. This phase is the time to consider who is responsible for executing the project to estimate how well it might go. Contractor credibility is one of the main things to look out for and even consult with as many knowledgeable people as possible. Consider the budget and how well the construction team will likely adhere to rules and regulations. It is also good to consider the proposed milestones and how realistic they are.
Two main options manifest in the post-development phase: lease or sell the property. The project can also be used as collateral for a bigger one. Leasing and managing property will necessitate having a list of clients lined up. Consider the proposal to see client acquisition strategies and methodologies. The best option will be a building leased out for a given period before being sold. This way, you make back most of your investment and take a share of the sale. Management is a crucial aspect of the whole development process because this is how the building will hold value in the long term. Look at who will be responsible for maintenance and upkeep and how well they are suited to perform the task.
Now that you are well-acquainted with the development process, it is time to get into the nitty-gritty of underwriting. The process can be broken into three general segments: subject property, supply, and market demand.
A Practical Approach
“What we hope ever to do with ease, we must learn first to do with diligence.” – Samuel Johnson
Surrounding Area Analysis
“There is always light. If only we’re brave enough to see it. If only we’re brave enough to be it.” – Amanda Gorman
The first thing you should seek to know is the property’s area of location. You should also look to understand what area it is located. A property’s surrounding area is usually defined as a land area within a three-mile radius. Check out the area’s location and even its boundaries and delineation. The property’s specific location should also come here, although it will also be included in the next step. For instance, the case study property can be found in central Hernando Country and is located on the south side of Cortez Boulevard, east of Horse Lake Road in Brooksville, Hernando Country, Florida.
The property is also located in a semi-rural/semi-urban area. It also helps to understand the main access and linkages to the area of interest. The access further includes having a clear picture of the roads, highways, airports, traffic volume, and public transport. This information is important because access and linkages are tied to a particular market’s size and competition. When considering the case study of every property area, it is supplied by two major highways and four primary corridors with an average traffic volume. It is also a drive away from two airports.
The main modes of transportation should also factor in at this point, including understanding the main modes of transportation and the factors behind their rapid spread. For instance, the area the case study project is located in is mainly supplied by a bus service, with personal automobiles coming in a close second. Air transport is also available, with one airport located under 10 miles away and the second around 50 miles. This high-level understanding of the project’s area will facilitate a clearer understanding of what will likely occur over the investment’s duration.
When analyzing the surrounding area, be sure to look at demand generators. Demand generators are sources of clients and include employment centers, income, and population. This situation also means you should look at the major employers, average household income, and population in the surrounding area. For instance, the case study property is located where the Hernando County government is seated, which means a substantial number of well-paid civil servants. Further, there is a cement company, airport, a park, healthcare, and the closest senior citizen centers. All these employ high numbers of people, which translates to a substantial market for the proposed units.
Next, you should look to understand the surrounding area’s demographic profile, including income, household, and population. The three-mile radius is the most widely used standard, but you can also consider numbers within 1-mile and 5-mile radii. Taking the case study project, it has a three-mile radius population of around 12,000 with a median household income of $37,529. You can tie this in with a picture of the available services and amenities, including public services, types of schools, and health services. It is also worth considering the general land use in the property’s immediate vicinity and seeing how well it ties in with the proposed development.
Subject Property Analysis
“Don’t save your best for when you think the material calls for it. Always bring your full potential to every take, and be on top of your job, or they will replace you.” – Gabrielle Union
This step includes discussing and analyzing the property’s physical attributes, surrounding properties, linkages, and the externalities. Therefore, the second thing to do is to look at the site. The site can seem obvious and pretty straightforward, but important details should be kept in mind. Every offer and proposal to invest in or forward loans to investment opportunities comes in the form of an offering memorandum (OM). Offering memorandums give an overview of the site, the opportunity, and all high-level details concerning the property and proposed project, but there is a caveat. Offering memorandums are pieces of information created by sales associates, and they may go overboard with the marketing and give off-the-chart numbers and figures that will be impractical in the market. You should largely ignore the OM and find ways to view the site.
Google Earth is the fastest and easiest way to learn about the proposed property. This program is one of the most important resources real estate investors have at their disposal, and it should always be at the forefront of your mind whenever looking to underwrite an opportunity. It is remarkable how this software offers so much utility but is free! Google earth gives you access to an unprecedented amount of information about the site, so we will list things you should always check. However, with all their utility, programs, and services like Google Earth, CoStar, and Zillow can sometimes include pictures and images a few years old, so paying an in-person visit will serve you well. Visiting the site will allow you to feel what is possible and what is not.
Property analysis includes looking at a property’s features, including its location, dimensions, terrain and topography, surroundings, history, and elevation. Look at details like road frontage and square footage or acreage. Google Earth’s Google Street View lets you see the property’s surrounding area. The Google Earth Street View is a technology that has been adopted in google maps and google earth. This technology offers an interactive view and the outlook of various positions along streets in the universe. The technology was first adopted in the USA in 2007 to monitor the key American streets, and it has recently continued gaining usage across various parts of the world.
Therefore, look at possible deal killers like mobile parks across the street, ugly buildings, train tracks, and others using Google Earth Street View. It would be best if you also used this opportunity to look at the businesses, amenities, services, and competing projects. Again, considering the case study property, it is about 21.82 acres with 19.40 acres of developable land and is irregular in shape.
Indeed, other crucial elements to look at include ‘environmental’ (topography, soils, drainage, and flood hazard status), zoning, utilities, streets, access, and frontage. The way to go about environmental is ordering a soil report, flood hazard status, on-site retention report, and topography analysis. Utilities include local phone, electricity, sewer, and water. Zoning is another crucial element to know. You have to know if the property is zoned or not, and if so, what the current zoning is. Taking the case study property and considering all the above elements, it is served by several utilities, including water, sewer, electricity, and local phone services. It is under the zoning jurisdiction of the City of Brooksville, has a PDP zoning designation, and is approved for multi-Family residential. It is also good to know about any pending zoning changes.
Market Supply Analysis
“Don’t sit down and wait for the opportunities to come. Get up and make them.” – C. J Walker
This step involves taking an overview look of the area, understanding the market and demand generators for the proposed project, auditing existing inventory, and studying projects under construction and those planned and proposed.
Competition is one of the most important elements every investor should look out for before starting a project. It would be best if you had a firm understanding of surrounding buildings with the same offer. Always look at competition within a 3-mile radius. There are several ways to go about this, including using applications like Zillow but Google Earth stands out because it gives you a visual of the competition. Visuals allow you to make complex decisions about the project. You should understand as much about the competition as possible, including their rates and occupancy levels. CoStar does impressively in this regard as a source of real estate information, so be sure to check it out. More details to look out for using sources like CoStar include demographics within a three-mile radius, access to public amenities, distance to the downtown area, major intersections, and employers.
In this stage, you look at the project location’s attributes, surrounding population and demographics, demand generators, and forecasting demand. The demand for multi-Family developments is driven by location and demographics. Some of the elements in this section have been discussed above and are only used differently. Demand analysis requires that you estimate the proposed project’s growth and vacancy over the near future. A project’s value is directly tied to rent growth values as they determine the net operating income (Nguyen, 2019). A project’s location will determine its appeal to prospective clients since every location is directly related to proximity to employers, supply, demographic characteristics, and population density. The better the location, the better it is likely to perform. The case study report is located in a place with average characteristics across all these dimensions, meaning it is likely to have average performance that will grow over the long term as it is located in a growing area. Online databases like Yardi Matrix can also come in handy in helping you make accurate assumptions.
Other subtle but important elements to look for are how long the property has been on the market, previous offers, and the date and cost of the seller’s purchase. Go to websites like LoopNet to determine most of these factors. Knowing about them will give you a good idea of how other investors see and value the property. Also, look at other competing properties with similar characteristics and how they stack up against the proposed one. This process, however, might take much time, so tread carefully. Consider also the property’s tax assessed value to give you a better insight into its overall value.
Looking forward means assessing the project’s outlook over the near future, skipping the offering memorandum (OM) and going straight to financials. OMs often do not contain factual information which can assist investors. For instance, OMs are known to show the best pictures and units, leaving out those that are not as appealing. Therefore, understanding the OMs means you should visit the property to get a feel of the situation. This condition is true for both developed and yet-to-be-developed properties. So, always skip the OM and enter the numbers directly as investors. This avoidance is especially important for already-developed properties with a record of earnings. For undeveloped properties, you should look at the market study report as it gives an in-depth look at the property and its variables.
Looking forward is predisposed on how well you assess in-place revenue and expenses. In-place revenue is the income the property generates or will generate each month, including the leases and ancillary sources of income you expect to be present. In addition, it includes knowing the in-place base rent, contractual ancillary fees tenants will be paying, and future concessions that might reduce the income you expect to receive. This understanding is true for developed projects; for undeveloped projects, you will consider the regional and national market outlook to come up with estimations.
For developed properties, go straight to the T-12 and ensure you have up-to-date financials. A T-12 is a short form of trailing 12, which is the data on the property’s expenses and income over the last twelve months. This is the case for already-developed properties, unlike the featured one, which is yet to be built. The next important step is analyzing the T-12 and looking for irregularities. Properties are exposed to many abnormalities that might affect their value. Up-to-date cannot be emphasized enough because you do not know of recent events that might have triggered the listing. For instance, a recent fire or flooding is a significant determinant of a property’s appeal to future buyers or renters, and going in blind will set you up for failure. A tax reassessment can also mean lower profit margins. Watch out for these, as many owners will not disclose them readily. This reassessment is the point to consult with sources close to or attached to the property, like managers. The main point to look out for is vacancies, which should be within acceptable ranges without significant dips. Investigate any abnormalities to understand the reasons for the huge turnovers. For proposed developments, look at the expected occupancy and see if it matches what you can tolerate. Utility income, cross-reference with what they are paying and how much. Any other income implemented into the property. Also, look at what other properties are paying. Find ways you can add extra income to the property.
It is important to consider what does the project’s development mean to rent? The best way to go about this is to look at comparable developments that mimic the finished product of what you intend to create. You can look at similar properties in the submarket you operate in and determine the rent they command to get a sense of what you should be charging. The case study’s rent assumptions were made after comparing them to similar projects, including Spring Hill, Julep Apartments, Bembridge Sun lake, and others. From these values, investors can determine what rates will likely succeed in the market.
Solve for Valuation
Once you have all the information above and have projected cash flows, it is time to combine everything and come up with a valuation. The final value will usually be based on the specific goals of the investment, most of the time considering target return values for cash-on-cash, equity multiple, and internal rate of return (IRR). Most offering memorandums will present target figures for either one, two, or all of these metrics. You should always have your estimates in place and compare them with the presented figures.
“Diligence is the mother of luck.” – Benjamin Franklin
So, there you have it, the best way to go about underwriting a multi-Family development opportunity. The Multi-Family asset class is rising, and many deals and proposals are floating around. This book has shown you how to be in the best position to identify projects that will set you up to enjoy the upside without the undesired downside. Read this book multiple times before your first underwriting and any future ones to ensure you reap the maximum benefit from what is contained within. Thank you for picking up this book, and now you have the keys to a successful real estate career in the multi-Family space.
The major fortunes in America have been made in land. – John D. Rockefeller
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Gower, A. (2019). The Real Estate Development Process. Gower Crowd. Web.
Justin, O. (2021). Multi-Family Underwriting Case Study: Emeritus. Web.
National Apartment Association. (2017). The United States Needs 4.6 million New Apartments By 2030, or It Will Face a Serious Shortage | National Apartment Association. Www.naahq.org. Web.
Nguyen, J. (2019). 4 Key Factors That Drive the Real Estate Market. Journal of Investment property. Web.