Guide
How to Underwrite a Multifamily Deal (Step by Step)
Underwriting a multifamily deal means building a defensible cash-flow model that projects a property's net operating income, sizes its debt, and forecasts equity returns to decide whether the price and business plan justify the risk. You do it by normalizing the trailing-twelve-month (T-12) financials and rent roll into a stabilized Year-1 pro forma, then projecting NOI forward, applying financing, and modeling the GP/LP waterfall down to a levered IRR and equity multiple. The output is a go/no-go answer and the maximum price you can pay to hit your return targets.
Start with the rent roll and T-12, and normalize them
Every multifamily underwrite begins with two source documents: the current rent roll (a unit-by-unit snapshot of in-place leases) and the trailing-twelve-month operating statement (the T-12). The rent roll tells you in-place rent, unit mix, occupancy, lease expirations, and loss-to-lease (the gap between in-place and market rent). The T-12 gives you the last twelve months of actual income and expenses, which you normalize by removing one-time items, annualizing partial-year line items, and adjusting for anything a new owner's cost basis will change (property taxes on reassessment, new insurance quotes, replaced payroll or management contracts). Never underwrite off the seller's pro forma — it reflects their best case, not your operating reality. Reconcile the rent roll's annualized gross potential rent against the T-12's rental income line; a large unexplained variance is a red flag worth chasing before you go further.
- •Rent roll: unit mix, in-place vs. market rent, occupancy, lease-expiration schedule, loss-to-lease
- •T-12: actual income and every expense line for the trailing twelve months
- •Normalize: strip non-recurring items, reset taxes/insurance/management to new-owner basis
Build stabilized gross potential rent, then subtract to effective gross income
Set your Year-1 revenue by starting from Gross Potential Rent (GPR) — every unit at market rent, fully occupied — then subtracting realistic deductions. Market rent should be supported by a rent comp survey of 3-6 truly comparable properties (similar vintage, unit type, submarket, and amenities), not the seller's assumptions. From GPR, subtract vacancy loss (use the greater of in-place, submarket, or a conservative 5-7% floor), then loss-to-lease, concessions, and bad debt/credit loss. Add ancillary income — RUBS utility reimbursements, parking, pet rent, laundry, storage, application and late fees. The result is Effective Gross Income (EGI), the revenue the property actually collects.
- •GPR = all units × market rent, at 100% occupancy
- •Less: physical vacancy, loss-to-lease, concessions, bad debt
- •Plus: RUBS/utility reimbursement, parking, pet rent, other ancillary income
- •= Effective Gross Income (EGI)
Underwrite operating expenses and arrive at NOI
Project operating expenses line by line rather than as a blanket percentage, then sanity-check the total against per-unit and expense-ratio benchmarks. Typical stabilized multifamily expense ratios run roughly 35-50% of EGI depending on age, size, and whether utilities are owner-paid. Core lines: property taxes (reassess at your purchase price where applicable — this is the single most common underwriting miss), insurance (get a live quote), property management (typically 3-5% of EGI), payroll, utilities, repairs and maintenance, turnover, marketing, contract services, and administrative. Effective Gross Income minus total operating expenses equals Net Operating Income (NOI) — the property-level cash flow before debt service and capital items. Critically, exclude from operating expenses: mortgage payments, capital expenditures, depreciation, and income tax; those sit below the NOI line. Reserve a separate replacement-reserve line (often $250-$350/unit/year) that lenders will require.
- •Reassess property taxes at the new basis — do not carry the seller's number
- •NOI = EGI − operating expenses (excluding debt, capex, depreciation, income tax)
- •Benchmark: expense ratio and $/unit against comparable stabilized assets
Project the hold, size the debt, and layer the capital stack
Extend Year-1 NOI across your hold period (commonly 5-10 years) with explicit growth assumptions — rent growth, expense growth, and a value-add ramp if you're renovating units to push rents. Model the exit by applying a going-out cap rate (usually 25-50 bps softer than your going-in cap to stay conservative) to forward NOI, then subtract selling costs. Size the loan against three independent constraints and take the lowest proceeds: loan-to-value (LTV), loan-to-cost (LTC) on value-add deals, and a debt-service-coverage-ratio (DSCR) test, with debt yield increasingly the binding lender metric. DSCR = NOI ÷ annual debt service; agency lenders typically want 1.25x or higher. Layer the full capital stack — senior debt, then any preferred equity or junior/mezzanine debt, then common equity — and model a mid-hold refinance if the business plan calls for a cash-out once NOI stabilizes.
- •Exit value = stabilized forward NOI ÷ going-out cap rate, less cost of sale
- •Debt sizing: min of LTV, LTC, and DSCR/debt-yield constraints
- •DSCR = NOI ÷ annual debt service (target ≥ 1.25x for agency debt)
- •Model preferred equity, mezzanine, and any mid-hold refinance in the stack
Model the equity waterfall and compute levered returns
Property-level returns are only half the story — the deal's economics depend on how cash flow and sale proceeds split between the general partner (GP/sponsor) and limited partners (LPs). Build the equity waterfall: first return of capital, then a preferred return to LPs (commonly 7-9% annually, cumulative), an optional GP catch-up, then a promote (carried interest) split above each IRR hurdle — for example 70/30 to an 8% hurdle, 60/40 to 15%, and so on. Include a clawback provision if you're modeling GP incentive fees against final results. Run the levered LP cash flows through to the two return metrics that matter to investors: levered IRR (time-weighted) and equity multiple (total dollars returned ÷ dollars invested), plus average cash-on-cash. Finally, stress the deal — run two-variable sensitivity on exit cap rate versus rent growth, and versus interest rate — because a return that only survives one set of assumptions is not underwritten, it's hoped for.
- •Waterfall tiers: return of capital → preferred return → catch-up → promote splits
- •Report levered IRR, equity multiple, and cash-on-cash to LPs
- •Sensitize exit cap rate, rent growth, and interest rate before committing
Step by step
- 1
Gather and normalize the source documents
Collect the current rent roll and trailing-twelve-month (T-12) operating statement. Strip one-time items, annualize partial-year lines, and reset taxes, insurance, and management to a new-owner basis. Reconcile rent-roll GPR against T-12 rental income and resolve any material variance.
- 2
Build stabilized revenue to EGI
Establish market rent from a 3-6 property rent-comp survey. Compute Gross Potential Rent, then subtract vacancy, loss-to-lease, concessions, and bad debt, and add ancillary income (RUBS, parking, pet rent, fees) to reach Effective Gross Income.
- 3
Underwrite expenses and calculate NOI
Project each operating-expense line — reassessing property taxes at your purchase price — and benchmark the total against per-unit and expense-ratio norms. Subtract operating expenses from EGI to get NOI, keeping debt, capex, depreciation, and income tax below the line. Add a replacement-reserve line.
- 4
Project the hold and model the exit
Extend Year-1 NOI across a 5-10 year hold with explicit rent- and expense-growth and any value-add ramp. Apply a conservative going-out cap rate (25-50 bps above going-in) to forward NOI and deduct selling costs to estimate sale proceeds.
- 5
Size the debt and build the capital stack
Test loan proceeds against LTV, LTC, and DSCR/debt-yield constraints and take the lowest. Confirm DSCR = NOI ÷ annual debt service clears the lender's minimum (typically 1.25x). Layer senior debt, any preferred equity or mezzanine, common equity, and any mid-hold refinance.
- 6
Compute property- and deal-level returns
Derive going-in cap rate, unlevered and levered cash flows, and Year-1 cash-on-cash. Roll the levered cash flows and sale proceeds forward to compute levered IRR and equity multiple for the partnership as a whole.
- 7
Model the GP/LP equity waterfall
Split distributions through the waterfall: return of capital, preferred return to LPs, GP catch-up, and promote tiers above each IRR hurdle, with a clawback if applicable. Report the LP-level IRR, equity multiple, and cash-on-cash separately from the GP's.
- 8
Stress-test and decide
Run two-variable sensitivity on exit cap rate vs. rent growth and vs. interest rate. Confirm returns survive downside cases and DSCR holds. Then set your maximum purchase price to hit target returns and issue a go/no-go conclusion.
Frequently asked questions
- What is the most common mistake in multifamily underwriting?
- Carrying the seller's property-tax number instead of reassessing at your purchase price. In many jurisdictions a sale triggers reassessment, and taxes are often the largest single operating expense — understating them inflates NOI and overstates value. The second most common error is underwriting to the seller's pro forma rents rather than to a defensible rent-comp survey.
- What DSCR and cap rate should I underwrite to?
- There is no universal number — both are market- and asset-specific. Agency multifamily lenders typically require a DSCR of at least 1.25x, and debt yield is increasingly the binding constraint. For cap rates, use current transaction comps for your going-in rate and underwrite an exit cap 25-50 basis points softer to stay conservative, since you're forecasting a sale years out.
- What's the difference between a levered and unlevered return?
- Unlevered returns measure the property's performance with no debt — the all-cash IRR on NOI and sale proceeds. Levered returns add financing: they reflect the actual equity cash flows after debt service and loan payoff, which amplifies both upside and risk. LPs care most about the levered, after-waterfall IRR and equity multiple on their invested capital.
- How long should a hold period be in the model?
- Most value-add and core-plus multifamily underwrites use a 5-year hold, with 7-10 years for longer-term strategies. The hold should match the business plan — enough time to execute renovations, stabilize NOI, and capture rent growth, while a mid-hold refinance can return capital earlier. Always test how sensitive your IRR is to hold length, since time-weighted returns fall as the hold extends.
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