PART 2 - How to underwrite for Investor Real Estate

First, I wanted to thank you all for subscribing to my news letter! This all started with me watching the opening round of the NCAA basketball tournament. Both UVA and VCU had lost in the first round, next thing you know I am typing out a new LinkedIn article on Investor Real Estate at 11:00 PM on a Friday night.

I never would have guessed that close to 600 people would join along within the first two weeks. I went back and re-read my first article, realized I probably left some important insights out. So, I wanted to revisit this topic one more time before moving on.

For this article, I want to continue building on the previous foundation we established and equip new investors with a tool that can help them asses a property quickly. Below is a screenshot of a simple Excel sheet I made that incorporates all of the terms and definitions I covered in my previous article.

Previous Article Can Be Found HERE

Link to download this exact Excel file can be found HERE

Again, this is just a TOOL, meant to help investors with quickly assessing a property to determine if it is worth pursuing, primarily with a conventional bank loan.

Complete the Excel form in the following steps:

1. Asking Price - This is the total amount that the seller is asking for. Note, there will most likely be a difference between this amount and cell B13. B13 calculates the value of the property based on the CAP rate and the NOI. Any difference will ultimately need to be negotiated down or paid with additional cash at closing, more on this later.
2. Loan Amount - This is the total amount that you want to borrow from a bank to complete this purchase. After you input your number, first check cell E4. E4 will show you your Loan-To-Value (mentioned in the previous article). Most banks will want this at or below 75% (depending on the property type). Next, you will want to look at cell B14, but you will first need to complete the rest of the form to generate a value in B14. So we'll come back to that.
3. NOI - This number will come from the property owner or real estate agent selling the property. Be sure to put in a number that has accounted for all possible expenses that could arise during your ownership of the building. Sometimes NOIs will be listed inaccurately, or in a way that is not easy to determine. For example, you will want to see if the property is considered a Single, Double, or Triple Net Lease. Single net leases typically require the tenant to pay property taxes, while double net leases require the tenant to pay property taxes and insurance. Triple net leases, on the other hand, require the tenant to pay for property taxes, insurance, and maintenance costs. From an investment standpoint, triple net leases can be particularly attractive, as they often provide greater cash flow and fewer landlord responsibilities. However, investors should carefully consider the risks and benefits of each type of lease before making any decisions.
4. CAP Rate - It's best to start with a CAP rate that is provided by the seller or real estate agent. However, a CAP rate is really only truly determined at the time of the sale. Many sellers will back into a CAP rate by seeing how much they want to sell the building for and then comparing that to the current NOI. As an investor, you will want to look at the CAP rates from comparable properties that have recently sold. A banker should be able to give you insights into historical CAP rates for different markets and for different property types. You will probably enter a few numbers here to see how the excel sheet acts, and finding the best CAP rate will help ensure you buy a profitable property at the right price.

After this, you will move down into the Financing Information section. For this, you will need to partner with a banker to get the best data. It's important to note that bankers can only give you general guidance on this. All deals will go through an underwriting process by every bank before a true term sheet is generated for you to consider. However, you should be able to gather enough information to aid in your quick assessment of a new property.

5. Interest Rate - One key item to look for here is to determine what benchmark the bank is using to set the interest rate. This can be anything from Prime, SOFR, a treasury yield, or any other metric used by the bank. If the banker says something along the lines of "we can use SOFR + 2.5% for this type of deal", then all you will need to do is a quick Google search for current SOFR and then add 2.5%. Some key things to consider, rates are always changing, and bankers really aren't able to provide direct/specific quotes on rates without proper underwriting. So, take this number as a "best and reasonable" guess.

6. Amortization - This is pretty straight forward; you just need to determine how long the bank will stretch the loan out. Note, this doesn't consider anything with the "term" of the loan, as that is something that can be negotiated later on with the bank. Different term lengths can be attached to the same amortization period, and different term lengths have different interest rates. Once a term is completed, the loan will need to be refinanced either with the same bank or with a different financial institution.

7. Debt Coverage Ratio - I will say most banks want to see debt coverage ratio of 1.25, but it's always worth asking as it could change based on property type and market conditions. This ratio shows the bank how much money you are making for every dollar in debt repayments you would be expected to make. Meaning, for every dollar you are expected to pay back to the bank, the property is generating $1.25 at a debt coverage ratio of 1.25.

From here, you'll be able to see the data calculated in cells B13 - B18. This is where you will most likely want to revisit some of the cells from B3 - B6.

It's hard for me to give much guidance here, as the decision will really come down to you. How much cash do you have on hand, how much do you like the property, and what is your overall investment strategy.

Hopefully though, this tool can get you going in the right direction quickly. This is a simple tool for exploring bank financing. There are many ways to acquire investment properties beyond bank financing, but I'm not really an expert in those methods. However, I know there are many great banks out there that have many happy clients. I recommend you reach out to different banks, especially different size banks, to make sure you are finding the best options.

Thanks again for joining along! Stay tuned in the weeks ahead as we explore more topics and insights around commercial banking. Give a "like", leave a comment, and share with others.