Multifamily Fundamentals is a 10-part series hosted by multifamily investor and syndicator Matt Faircloth of the DeRosa Group. In each episode, Matt and his guests dive deep into the fundamentals of not just investing in multifamily, but in building a real estate business. They dissect everything from choosing the right market, to underwriting and financing multifamily properties, to mastering investor relations — all the way to building out your multifamily dream team.
Matt Faircloth and Herve Francois discuss multifamily underwriting, emphasizing its importance in the real estate business. They explore the roles within their company, DeRosa, highlighting the hunter's role in identifying investment opportunities and the underwriter's role in analyzing and implementing business plans. The discussion includes strategies for scaling a business, the significance of market selection, and the intricacies of underwriting, such as assessing market attractiveness, building relationships, and detailed property analysis.
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Transcript
Matt Faircloth @TheMattFaircloth (00:03.481)
What's going on best ever community? This is Matt Faircloth doing the guest host of the best ever podcast here. Super grateful for you guys being here and grateful for the opportunity for our company, DeRosa to be a contributor to the best ever show. We got a great show for you guys today. We're gonna be talking about underwriting for multifamily and what better co-host brother from another mother to come join me today is my partner, Hervé Francois to come talking about underwriting. Hervé, how are you?
Herve Francois (00:30.382)
Very well, man. Thanks very much for having me. So excited, pumped up to be here with the best ever community. Let's get going, let's get going.
Matt Faircloth @TheMattFaircloth (00:36.313)
Yeah, let's do it, man. So guys, we got a lot, it's, underwriting is kind of like the unsung hero in a lot of ways in multifamily. Everybody wants to talk about how much money you can raise and how many deals you've done, which is all money and Hunter. But a lot of the real implementation side, the real dollars and cents are made in the creation of a plan, and then in the implementation of that plan. In some ways, we've read the book Traction, not the visionary side of the business, the integrator side of the business.
So we're gonna talk about underwriting and that is a department in our company, DeRosa, that Herve is in charge of. He's not the underwriter. Herve is our hunter. So Herve goes out and creates the opportunities, kicks the doors in that are closed for DeRosa and reels in the fish, so to speak. But those fish are cleaned and fried by the underwriter that works under Herve's division of the company. So before we get further here, I want to just highlight something, right?
We've talked on these episodes and we'll continue to talk about the four quadrants, AKA the core form method that we've broken our company up and it's allowed us to really, really scale quickly 10Xing our business over years. And by implementing this process, if you guys are a hands-on multifamily operator, we believe that by you guys implementing a lot of the technology we talk about on these episodes, you guys can grow that way as well. So Irvay, to quickly highlight, you're the hunter on the DeRosa team and that is the first leg of the of the of the of the you know of the stool here right the first superpower. So tell us briefly the hunter does what and then we're going to move into the other ones and get into the brain which we're going to talk about today.
Herve Francois (02:14.35)
So great question, Matt. Basically, the hunter's role, the hunter's responsibility is to go ahead and identify which market his team is going to invest by looking at a bunch of different metrics out there to identify what's an attractive market for the team to go ahead and invest. And once the hunter does that, it's the hunter's responsibility to go out there and develop relationships with brokers and folks other part of the real estate team, contractors, property managers, and so on and so forth, to start the process of looking for a property to acquire. So it is a process, it is putting the metrics, looking at the metrics in place to identify an attractive market from there, building relationships with the brokers to go out and find properties to acquire.
Matt Faircloth @TheMattFaircloth (02:59.785)
There you go. To the hunter, finds the market, and then infiltrates that market for their business, right? Then the brain is the one that we're gonna talk about today, and they take those opportunities, and they take them and turn them into a business plan. The other two components on the team are the money, which is my side of the business, which is them providing the equity resources, the dollars and cents to invest in the deal. Then you get the hammer.
That's Justin Fraser that's there to take all that potential energy that we've created there and turn it into reality. So today's conversation is about the brain. Like I said, in some ways the unsung hero, the person that enjoys living in spreadsheets and sitting on a desk in the corner and squeezing out opportunity out of a potential deal, doing all the detective work that it takes. So let's talk about it. So Herve, you work very closely with our underwriter.
When you produce a deal, I get you're already, in some ways the hunter and the brain are so much connected that there's a bit of a fuzzy gray area between those two seats, right? So when you produce an opportunity, you're already thinking of what our underwriter needs to create that, to take that into fruition. So what are some of your, your broker sends you a deal, right, you're gonna do some cursory overview on the deal and then you're gonna take it over to Haith. Talk us through that, Haith is our underwriter. Take us through that process on deal hits your desk to what you do first, and then your initial conversation is on the underwriting team.
Herve Francois (04:27.37)
No, absolutely. So the first thing that I do once a broker sends me a deal, I want to make sure that the broker sends me the correct and updated information on that deal. And it's typically three items for a quote unquote listed deal, right? And it's going to be number one, the offering memorandum that broker has put together, the trailing 12 abbreviated as T12. That's the last 12 months of let's say profit and loss statements of that particular property.
And lastly, the rent roll, right? So I'm going to have all three of those documents, but before digging into the numbers, and because I know I have our super heavy duty underwriter to dive in on the numbers, I'm not gonna touch the numbers as much as I'm gonna probably open up, take a look at the offering memorandum, and I'm gonna put together a summary sheet. I don't know if Matt and Justin even knows this, but I do a summary sheet on every single one of these properties that comes across my desk that we may be interested in acquiring.
And that summary sheet is usually about a page, a page and a half long, but it's a summary of obviously the location, also the number of units and how it's broken down by one bedrooms and two bedrooms and the average asking rent for those and the average square footage. I'm going to also summarize who's the current property manager, what price it was bought, you know, several years ago and who's the current owner. I'm gonna take a look at the amenities of that property, both interior and exterior.
One of the first images I always jump to go to take a look at is the kitchen to see what condition it's in. And then, you know, my light bulb will pop off and say, hey, there's an opportunity here because we can go ahead and improve all the kitchens in this property and so on and so forth. So I'm gonna go ahead and do that summary.
And truth be told, man, I mean, I'm cheating a little bit here, but because I know our market so, so well, I already have an idea when I glance at the numbers that, hey, this could be an interesting deal for us to go ahead and take a look at. So that's the very first thing that I'm doing, that one page summary on the deal before going ahead and even sending it to our heavy duty underwriter so he can go ahead and start analyzing and underwriting the deal.
Matt Faircloth @TheMattFaircloth (06:45.777)
Guys, I want to underscore a few things here. Number one, the second episode that DeRosa did for the contribution to the Best Ever Show, you guys want to go back and re-listen to. That's where Herve and I were on before. We talked about market, right? And one of the highlights there was that you got to pick one market, not seven, not 10, not 34, not even two. One market that you guys want to focus on. And one of the many, many benefits you get from being able to do that is, as Herve said, when a deal hits your desk, you're just like, oh, they're asking 105 a door.
Every other thing I've seen in this market has been in 150 a door. So either something's wrong or this is a really underpriced deal and this could be an opportunity. And you'll know that off the top of your head. Like, oh, I looked at, this is my market. This is my sandbox. I know what it should price in at. I know what rents are because this is what I look at. It's such a power.
Herve Francois (07:30.173)
Absolutely.
Matt Faircloth @TheMattFaircloth (07:43.757)
and drilling into a specific market, right? Yeah, yeah, I love the, was that, yes.
Herve Francois (07:46.05)
Really? Yeah. It works both ways. It works both ways, not only when I'm given a property and the broker tells me, well, this is how much the asking price is on a per door basis. And I look at that, I'm like, hmm, that seems well above other deals that have been sold in this market over the past couple of years. But it works in reverse when I'm showing a deal and the asking price is well below what other deals have sold in the market over the past 12 to 24 months.
That tells me, hmm, what now? I could jump at it and say, oh, well, we got to go after this one because it's so attractive. But before I jump to that conclusion, I'm like, hmm, what's the location of the property? What's going on? What's wrong?
What's wrong? You're like, something wrong. I know something's wrong. The broker knows what they're doing too. Something's wrong. Let's find out what's wrong first. Right? So interesting. I also think that what you've taught me is a lot of things that you're going to do. And listening to our audience here,
Matt Faircloth @TheMattFaircloth (08:48.741)
You guys are going to, before you send it over to your brain or even start underwriting yourself with your other brain, you're going to make sure this deal fits the buy box. And this sounds obvious, but you do want to, you don't want to chase shiny nickels or waste your precious time underwriting a deal that is outside the buy box of your organization.
Meaning like, you don't want to go taking something that you've agreed with your partners that you're not going to do. And hey, this deal actually looks pretty good. Let me go bring it to my money and my hammer person and say, no, we don't want to, but we're looking for 50 to 100 units, not 10 units. Or we're looking for deals in Winston Salem, North Carolina, not Raleigh, North Carolina. So the deal that gets sent to you by a broker could be inadvertently outside of your geographic buy box, outside of your size buy box. It may also be outside of your vintage buy box. I'm not talking about wine.
I don't want to talk about vintage. I'm talking about the age of the building, when it was built. Some people only want to do stuff that was built, like let's say for making it up, after 1980, 1985, 1990, 2000, whatever. Or other folks are okay with older assets that may have more issues, but you're gonna get for a better price. Less folks are gonna be interested in it. So if you know how to handle something built in the 70s or 60s, then you might want to add that to your buy box as well.
Probably lowers your competition, whatever your buy box is, you want to filter that deal before you send it to your underwriter and go spending their precious time on a deal, make sure that deal fits the buy box your company has. So Zerwe said he's gone and done that curser review, cursory evaluations. You throw it off to your underwriter. Let's go through the data that they need to pull down.
And before I even say that, they're going to be taking a lot of their analysis and doing it in some form of a spreadsheet, some form of an analysis tool that's going to spit out, green light, red light on this deal. Right, there's all kinds of analysis tools out there. We have one in-house that our students get a copy of through our accelerator program. So those that are already enrolled in that can use ours. And there's a million others out there that you guys can use. And a lot of folks that I know that are in the multifamily world, for better for worse, have developed their own underwriting tools. That's what we did. And now we offer ours to our students, right?
So in whatever tool you're using, the underwriter is going to then go collect data and drop it into their underwriting tool. And then they're going to play with it until the deal makes sense or it doesn't, right? So, Ravie, let's talk to some of the data they're going to pull down. What are some of the things that you think are the big rock data items that have to go in that sheet first?
Herve Francois (11:35.926)
Well, the first thing that our underwriter does is that he goes ahead and takes that trailing 12, the T12, propanol state, I was talking about, and he goes ahead and he puts it into his underwriting sheet, right? Just to really get a gauge. And we're looking back over the past 12 months, the performance of this property, the volatility, particularly in the large line items, whether it's on the rental income and then on the expenses, what's been going on with payroll or landscaping and so on and so forth.
And then the second thing he does, he takes that rent roll spreadsheet from the broker. He also goes in and uploads that into his underwriting model. And now we're taking a look at, you know, how many residents are 30 days late on their rent, 60 or 90 days late, trying to get an idea of what the is by looking at the rent roll versus what the occupancy number is in the offering memorandum. Sometimes it's not seeing eye to eye and so on and so forth. Right? So that's what that's the first thing that he's doing. So we are looking historically before we are building a pro forma, looking out the next five to ten years how long we plan on holding the property. Right? Because that's when we start looking into the assumptions that are going to drive
Matt Faircloth @TheMattFaircloth (12:45.929)
that you start looking into the assumptions that are going to drive it or drive it to your business plan. Right? And so, rather than just looking at what the other person is, here's who they're going to be looking to read the load information about the market. So they have to assess it. What should I look for when the forecast red-coats the big problem that's what I'm saying? What should I look for in this case?
Herve Francois (12:50.634)
our five to 10 year business plan, right? And so that is when, guess what? The underwriter, he or she, they're also going to need to know information about the market when they are assessing what should I go ahead and forecast rent growth to be over the next five to 10 years? What should I forecast, you know, pet income? What should I forecast the expense line items? We are all constantly now talking about insurance as you very well know as well as payroll and maintenance and repairs and things like that.
So that is on the forecasting side. So it's good to have an understanding. You need to have an understanding of the market that's going to help you do the projections of your numbers and things like that when you start talking about capitalization rates and so on and so forth. So those are the first couple of things he does. Taking a look at the performance of this property on a historical 12 month basis.
And then from there, starting to build out the projections on what this property can do, which is not only based off of the market forecast, but also what's our business plan for this property over the next five to 10 months? Are we renovating units or are we renovating 95% of the units? And what kind of impact does that have on our projections going forward?
Matt Faircloth @TheMattFaircloth (14:11.261)
There's a certain level of like, if you guys ever hear the term trust but verify, right? That is an underwriter, I mean, I get it. You don't wanna just go in there and call these, the brokers and the sellers just liars straight out of the gate, right? You're going to say, okay, the broker's saying that the owner has renovated 25% of the units, so let's take that for gospel and say that they've done that, right? And so I've seen you and Haith do that and put it in the underwriting, but then Haith will point out, I've had him, I've talked to him on the phone, he's like.
Herve Francois (14:16.411)
Oh yes.
Herve Francois (14:24.736)
Oh, this is great.
Matt Faircloth @TheMattFaircloth (14:39.709)
Well, the broker said they renovated 25% of the units, but guess what? I'm not seeing any difference in rents in any of the units. So there's no rhyme or reason. If they did renovate those 25% of the units that they have, they're not getting any premium. So either that means that they're really, really crummy managers and they really are not commanding from the market, the value that they should for the work that they did, or, or maybe we shouldn't renovate the other 75% of units because we're not going to get bang on our buck, right?
Herve Francois (14:45.087)
Right.
Herve Francois (14:53.943)
Right.
Herve Francois (15:09.174)
Absolutely.
Matt Faircloth @TheMattFaircloth (15:10.361)
And that's the trust but verify side of it. Obviously, we've seen brokers come in and say, hey guys, this owner is getting $800 a unit for a one bedroom and that property across, this other comp over here is getting $1,000 for a slightly better kitchen, a little bit better renovation around the same square footage. Now, that's trust but verify.
I can get $200 a unit, which doesn't sound like that much for these you guys that are newer to multifamily, but guess what? That adds up quick. $200 a unit times 100 units times 12 months adds up to an enormous increase in top line revenue, which then flows to your bottom line applied to the cap rate, makes that property worth a lot more if you can execute that business plan of doing all those renovations, pushing rents by 200 bucks systematically through the market and getting your tenants to agree to pay you more for the value you've created in their unit condition and making it a little bit nicer.
Now, Hayth then going to validate that $200 really does exist. And Irving, as you know, we've been told, oh yeah, there's your comp right there, that one bedroom property over there. And you realize that, okay, that property is like, two towns away from the one that they're trying to, or like multiple miles away in a different school system
proverbially on the other side of the tracks, good side of the tracks, bad side of the tracks, whatever it is, or it could be right next door, right? But we need to verify that the business plan is to take the unit, the property from A to B, and the question is like, what is B? And so let's look at other properties in the market. Hayes told me that he's gone in on apartments.com, on the websites for these properties.
He's even just because he's a data guy like this. He's called him. Think about that. Like, hey, I work for DeRosa Group and I'm trying to evaluate apartment buildings in your market. Looks like you've got some one bedrooms. Can you tell me the condition of your ones? Think about the Cajones there. Yeah.
Herve Francois (17:07.375)
That's it. Yeah.
Herve Francois (17:13.41)
Right. Yeah, he calls the comps. He calls the comps. Absolutely. No, listen, that's part of the homework, if you will. Right? And he really, really enjoys it, but it's drilling in. It goes to your point, man, in regards to trust but verify. Right? I mean, the broker's going to present this property in some really, really bright LED lights because they want you, the potential buyer, to buy this thing, gonna make it look real pretty.
I know that we've looked at properties and the offer memorandum shows a big, beautiful, extremely clean Olympic-sized swimming pool. And then we go to visit the property and like, wait, wait a minute. There's like bicycles and like lawn chairs at the bottom of this pond.
Matt Faircloth @TheMattFaircloth (17:58.289)
No, we did a dealer of a North Carolina where they had like, they had photoshopped the picture. Remember that? They photoshopped the pictures of the pool. And we go out there and it was like the swamp thing was about to come out of this pool. Right? And the pool needed like 60 grand worth of renovations work. But in the pretty little pictures, it's blue waters. They had a floaty in there and everything like that. That was ready to go. Like, oh yeah. Yeah. Just, just everything was ready to roll.
Um, in that, but you walk outside, pull like this does not match this photo. I don't think. Huh? Yeah, I know. Right. Can I get the directions to that pool? Cause this is, this is not that pool. Maybe this, that pulls the other side of the complex or something like that. Anyway, I'll joking aside guys. Uh, you trust that needed to get verified. Trust, but verify it. Right. Um, anyway, I, yeah, good.
Herve Francois (18:29.338)
Right. It wasn't. No. We hit the right property. Wait a minute. Yes. Right. That's all y'all.
Right. Yes.
Yeah. Right. Yes. So it's, yeah, but listen, and to your point in regards to number of units that have been renovated right now, trust but verify, Matt, guess what? That works the other way around also, where all of a sudden the broker tells us, and I would say there's 100 units on the property, and the broker tells us that you know, 55 of the units have been renovated. We go ahead and take a look at closer to 70, 75, all of a sudden realize, well, there's nothing left to squeeze out of this sponge. Right? I mean, so we're not, you know, even if you can get value of the remaining 25 units that have not been renovated, this is not enough to go ahead and provide attractive returns for us or our investor. That's it.
Matt Faircloth @TheMattFaircloth (19:28.129)
Yeah, there might not be enough work to do. If the business plan in this day and age at today's cap rates and today's interest rates, and just true anytime, and not just today, but yeah, I mean, typically deals are a little, you got to do something. I've heard a friend of mine say, you don't buy good deals, you make good deals. So you need to have a plan to take the property from A to B. It's rarely going to just buy it at A and get behind the wheel and drive. You got to do something to it to make it a value.
And if that something is not there, then it might not be worth it. So there's all that validation that you got to do to determine that if I invest X in this property, I will yield Y in increased revenue or in decreased expenses. A few decreased expenses items that the underwriter, the brain is going to look at is maybe utility conservations in some states passing over utility expenses over to the tenants through technology called RUBs, ratio utility billing systems.
I think I got that right, Herve, for what RUB stands for. Did I get it right? Tell them what is one. All right. I won the prize. Okay. Cool. All right. So that's RUBs. In some states that's legal, in some states it's not. Okay. But there's other things you can do like low flow toilets, LED lights, those kinds of things to reduce your utility consumptions.
Herve Francois (20:31.898)
You did? You got that right? You got that right? You got that right? Yeah, that's it.
Matt Faircloth @TheMattFaircloth (20:51.601)
there's other things you can do to reduce operating expenses overall. Um, so those are things you do to open up and do your value add. Then there's other research that they're going to do. Right. Um, or they tell me real estate taxes on a property. It just, they just, when you buy a piece of property, real estate taxes are guaranteed to stay the same for the next 15 to 20 years, typically on a piece of real estate, right? Just, and then the local government will guarantee it. And that they will not, is that, is that true? That's how it goes? No. Oh man.
Herve Francois (21:15.892)
Ugh.
No, furthest thing from the truth. Furthest thing from the truth. So now, again, you have to, in your projections on how this property is going to operate over the next five to 10 years, you have to have an understanding of the local real estate property tax laws, right? And exactly how do they change, what affects it, and when do they change, kind of a thing.
Matt Faircloth @TheMattFaircloth (21:22.478)
Oh man, oh man.
Matt Faircloth @TheMattFaircloth (21:39.333)
Mm-hmm.
Matt Faircloth @TheMattFaircloth (21:45.926)
Yeah.
Herve Francois (21:46.93)
and every state is different. Please, please, please help.
Matt Faircloth @TheMattFaircloth (21:49.101)
Yeah. South Carolina is crazy. I mean, you got to be careful there. It's fine. Guys, we shop in South Carolina for assets, but I'll give you an example. And there's ways around this, not to get too complicated, but typically, if you buy an asset in South Carolina, your property taxes get re-accessed to your purchase price number day closing. Congratulations, you got a new tax bill, right? So if the prior owner bought a property for $5 million and their taxes are X, and you then, and they've owned that property for a while, and then you go buy that property from them for $10 million.
Double what they paid. Your taxes will also double. Congratulations. Tell them what he's won, right? So you need to find out what the local rules are. Most of the time, states in local municipalities will reassess property value on an ongoing basis. We've done deals where the taxes were being reassessed inside of a year to 18 months.
Part of the underwriter's duties is to find out when that reassessment happens and what the tax reassessment protocol is, because they're going to underwrite the deal to likely future taxes, or if they're really savvy underwriters, they're going to underwrite to today's taxes for a little while, and then the tax bump when we believe it's going to happen. So that's a major part of the underwriting process, and we've seen real estate taxes make or break deals. Correct, Herve? Yeah.
Herve Francois (23:10.43)
Absolutely. No, we underwrote the deal a couple of weeks ago. Unfortunately, we had to pass on it because the reassessment of this deal was going to occur in 2025 and it was going to be a large, large increase. And it just really went ahead and took away from the returns because it was still within the three years that we had not yet refinanced that deal. So, yeah.
Matt Faircloth @TheMattFaircloth (23:34.705)
I wonder why they were selling your vey. I wonder what, huh. The taxes were gonna go up drastically in that two years from the time you were looking at the property. Huh, a good move on the seller to sell, right? And maybe it gets baked into the purchase price or maybe you catch someone who is not someone listening to this show. Maybe someone else out there that doesn't do their homework or whatever, for goodness for them, ends up buying the property, not realizing the taxes are gonna go up drastically.
Herve Francois (23:45.694)
Right. That's it. That's it.
Matt Faircloth @TheMattFaircloth (24:03.453)
Don't let that happen to you guys. Do your tax, your real estate tax research. Now, going back to Hi5RV again in here in his strong standard for us as a company for buying again and again and again in specific markets, right? What that allows us to do is if we're looking at yet another deal in the Piedmont Triad in North Carolina, we probably already know what local rents are. And so if you go with us and say, okay, I've got this asset that's achieving this rent.
Herve Francois (24:05.122)
Careful. Be very careful. Absolutely.
Matt Faircloth @TheMattFaircloth (24:32.893)
We already know what the rents are because we already own there. Right? And so a big value the underwriter can do is sure he'll do market research. He's also going to look into our rent rolls and assets we already own and determine if this property is a comp for something we already have. Right, Arvay? So how else does market data for stuff that we're already invested in, how else does that help us in the underwriting process?
Herve Francois (24:56.61)
Well, market data really helps us really in trying, and again, when it's time to go ahead and build out our projections and understanding, where we believe rent growth is going to happen over the next several years. Is this a market where the hourly wages for maintenance personnel working on your properties going up, right? And how that's going to impact. Oh my goodness.
Matt Faircloth @TheMattFaircloth (25:20.689)
Well, everybody earns the same across the country, don't they, Hervé? I mean, the same wage is X amount of dollars per hour for every job. Of course, people laugh because I like to make jokes like that as things that are completely obviously not true, but let's not make those assumptions. In you guys assuming that a labor technician gets X amount of dollars an hour in a deal and that doesn't change by the market, you're being as naive as I am pretending to be here.
Herve Francois (25:28.17)
That's right.
Herve Francois (25:48.622)
Right, right.
Matt Faircloth @TheMattFaircloth (25:49.389)
You want to know what the labor rates are in the market that you're in. And if you're invested already in that market, you kind of already know about what it's going to take to get the work done. So that's what's great about market focus.
Herve Francois (25:56.194)
Absolutely.
That's right. And all of this, you have to take into consideration. Again, this being a cyclical business, there's times when there is shortage on materials. And it's time to go ahead and renovate these units. And we're going to go ahead and put in brand new kitchen appliances. And oops, shortage on refrigerators. Shortage on stoves. And now, all of a sudden, the amount of units that you had expected to renovate in a given month is being held back because you're still waiting for materials to come in.
Sometimes there's not as many workforces, as many maintenance personnel on your property that you expected. So what would have taken perhaps two weeks to go ahead and renovate is now taking four to six weeks to renovate. Well, that is your property now not being able to capture that higher rent for an additional two to three weeks, right? That's having a negative impact on your numbers.
So these are the things that you certainly need to investigate. And that's going to be driven and really led by, that charge is going to be led by your brain, your underwriter. Now, he or she, they're going to have to rely on current market information to help them assess and underwrite some of the issues that they're going to run into in underwriting that property.
Matt Faircloth @TheMattFaircloth (27:03.817)
You're an underwriter. Yeah.
Matt Faircloth @TheMattFaircloth (27:18.309)
So a few other items here, guys. Insurance, right? I mean, everybody, not even make a joke about it. I mean, insurance has gone up quite a bit. And it will continue to, right? And that's partly due to an increase in the real estate market, partly due to the increase in construction materials, increase in labor, because, you know, God forbid, your property gets hit by a hurricane, tornado, whatever it is, the stick of lumber that's needed to put your property back into good working order is now more expensive.
And so that means the insurance carrier, rightfully so, should be charging a little bit more to insure you to get a stick of lumber at today's numbers versus five years ago numbers. I get, everybody wants to pay prices five years ago, I understand in that, but insurance has in some ways, rightfully so, gone up. Maybe there's a little bit of a money grab going in there too. Hey, capitalism 101, God bless them. But for one reason or another, insurance rates have certainly gone up, especially in low lying coastal areas.
Herve Francois (28:08.553)
Yep.
Herve Francois (28:12.022)
Right.
Matt Faircloth @TheMattFaircloth (28:18.293)
on the East Coast where we are, places like Wilmington, North Carolina, Charleston, South Carolina, Savannah, Georgia, those markets that are low lying coastals, meaning low altitude, right? Low lying and on the coast, Houston, Texas is another one. Yeah. Right. Now, these markets are not going to go anywhere. People are going to continue to live there, but the cost to ensure real estate in those markets is going up. Not just those markets, cost of insurance, period, has gone up.
So you cannot make the awful mistake of looking at the current owner's insurance burden and saying, well, Irvi, they're paying $300 a unit, current owner, so I can just either assume that policy, call their carrier and ask them to give me that policy or whatever it is. I can just assume that my insurance costs are going to be the same. Insurance has become so we, you know, folks used to do that and that was a safe assumption to make, but you can't do that anymore, can you?
Herve Francois (29:12.471)
Right.
No, can't do that anymore. Can't do that anymore, right? And this is where having a rock solid insurance broker on your team truly, truly helps out that you can reach out to him or her, let them know this is the property that you're interested in buying. They're gonna probably wanna take a look at the underwriting and whatnot. And of course the address. And then from there, they're gonna go ahead and shop for you and whatnot. But they'll be able to come back to you within 24 to 48 hours and give you an estimate of, you know, how much, you know, insurance is going to cost.
And you can take that number and put it directly in your underwriting. If you want to be more conservative, you can bump that number up by 10 to 15%. But that can make them nowadays, that is a make or break on whether or not you can really move forward on a property and whatnot. Simply because the insurance on a per unit basis just may price you out of acquiring that property, right? So.
It's something I think, and listen, that's before you started any renovation, any repairs, and so on and so forth. So it's something that, listen, we're all dealing with it, whether you are acquiring a property in a coastal area, whether you are acquiring a property inland. A lot of our stuff is in the mouth, and the insurance rates will still wind up increasing and whatnot. So you just have to adjust and plan accordingly.
Matt Faircloth @TheMattFaircloth (30:31.207)
Yeah.
You do, yeah. Great tips. So guys, summarize it all up on the pro forma side of the business, and we got to make a transition here. And you guys want to hear what's next here, but just to sum it all up, and we've talked about so far, what you've done is you trust but verify the numbers of the current owners given you. It's very hard to look at a deal, by the way, and this has happened to us, but looking at a deal, by the way, that the seller doesn't have this stuff. They don't have a rent roll and a T12.
Now sometimes most folks on larger assets are savvy enough that they have these kinds of things, but we've had plenty of sellers claim that I don't have a rent roll. I'm mom and pop back in the napkin running it. T12, I don't know. We'll see. Now, you either need to make your own assumptions in those cases. You need to either ask for the direct bills or give me the utility company's phone number and I'll have them send me the bills and I'll do the underwriting. You need to do a little more detective work.
So it's possible to build out a rent roll T12, and they perform an underwriting even if the seller doesn't give you this data. But unless something's really, really wrong, you don't want to... It's cautious. You have to be a little more cautious. They don't have everything you need because they could be trying to hide something or they might just... There might be something missing that they're not aware of that you're going to discover. So you can still underwrite a deal like that. You just got to be a little cautious. You're going to total up the business plan, look at where the property is.
Look at what you can bring it up to condition and revenue and expense wise based on the market. The broker is going to give you some guidance on that. Trust but verify. Doing your own research. As everybody said, you can do the photo comparison. Look at the pictures of the property you're looking at. It's kitchens and the pictures on apartments.com of the property right down the road. What's that?
Herve Francois (32:17.142)
Don't be misled. I said, don't be misled. Be very careful. Don't be misled. Watch my photos.
Matt Faircloth @TheMattFaircloth (32:21.337)
Yeah. Oh yeah. Watch for Photoshop, right? Watch out for Photoshop. And eventually, if you guys like the deal, you're going to go and go to the property and walk it. I forbid anyone listening to this podcast to submit an offer on a property you haven't put boots on the ground on. We're just talking about doing an analysis up until you make that offer. We have another episode on making offers and everything like that coming at you guys. But right now, this is about doing your analysis up until that point, right?
So you've built out a Proforma, which is a financial model that is in essence your business plan. I'm going to take rents from X to Y. I'm going to run in with these level of expenses. I'm going to manage it in this manner under this labor force. I'm going to do all these things. Then there comes a whole other angle here that I want to transition with you to, and that's finance. Then I got to buy it. I'm certainly, I got to buy the asset and I'm going to need to borrow money likely from a bank to purchase the asset and there's not just one way to do it. Talk me through the different finance options. And I know some of these have become way less exciting these days, right? But like just make it more macroscopic on the different finance options that people have when they're looking to buy multifamily.
Herve Francois (33:34.858)
Absolutely, absolutely. And a lot of that comes to the bigger the property that I'm not recommending anyone rush out and buy the biggest property that they can purchase. But not yet, not yet. But the bigger properties are going to have more options. When you start talking about smaller properties, limited options, but also good options, right? Good but limited options.
Matt Faircloth @TheMattFaircloth (34:00.721)
Yeah, small community banks.
Herve Francois (34:03.666)
That's exactly what I was going to say, small community banks, credit unions, things and loans, banks and so on and so forth. So those are some of the limited options, but very good quality options that you will go to in financing the debt to acquire a small to mid-size multifamily. And when we start...
Matt Faircloth @TheMattFaircloth (34:23.005)
I'll give a few caveats here before we transition to bigger. You're likely going to be signing a personal guarantee, right? Is what it is. From a small bank like that, is what it is. It's okay to get used to it. Personal guarantee just means that your personal guarantee, your personal stuff and personal assets are part of the collateral that the bank could come and decide that is theirs if you don't pay them back. So there's that. You are likely going to be little bit, maybe higher interest rate, but maybe higher loan proceeds maybe.
And you're actually, you're also likely to get a mandate from the bank that you have to open up a depository relationship with them. So, security deposits, operating accounts, those kinds of things that you have at the property are likely going to get moved to that bank in exchange for them giving you the loan, right? I've done a lot of small community bank loans in my years and it's just, you know, you kind of get to, you learn how to do the dance.
What's great about it is you're going to need, you're going to walk into that bank branch and get this look eye to eye with the person that's going to lend you the money. This is the transition point. They tend to get a little less excited the bigger your deal gets, which is where maybe over say like seven, eight, nine, 10 million somewhere in there, they're likely going to lose an interest unless they're a ginormous bank, unless they got their name on the side of a football stadium or something like that. Then a bank like that might be interested, but you're probably going to get a better deal, which is where you transition up to where Ervie's gonna take us next into financing on mid-sized multifamily.
Herve Francois (35:52.398)
So when you talk about financing in mid-size multi, right, now you're looking at, if you will, government-sponsored type loans, right? So you start talking about loans that are given out by the larger banks, but that are then gonna turn around and be sold to these government-sponsored agencies, be it Fannie Mae or Freddie Mac, right? And that just, they purchase these loans from these larger banks so they can go ahead and provide the to the banks as well, the banks keeping a lot of those loans off of their balance sheet and so on and so forth.
So typically, Freddie Mac, they're going to be purchasing loans from smaller banks and Fannie Mae is going to be purchasing loans from the larger banks. That's pretty much the difference between the two. Both of them offer a myriad of different kind of loan products, green loan products where if there's a certain amount of efficiency that's put into your property, they're going to give you a haircut on the rates. Obviously, both of them have a social component to their existence. And so they're very much in support of financing and lending out to purchases of affordable housing opportunities and whatnot, give you more favorable loan quotes if the residents in your property, if they have a median income slightly below the entire average median income of the market in which you are purchasing that property.
So this is not affordable housing, but just a little bit lower median income than average median income and so on and so forth. So there's a lot of different loan products. A very good loan broker, just like we were talking about insurance broker, but having a very good loan broker is going to help you introduce you to those different kind of loan programs from the larger commercial banks. And then there's something I'll call CNBS loan, collateralized mortgage, back security loans. These are loans that essentially are, again, given out by banks, but it's not on the bank's balance sheet so they can give you a little bit better loan terms on the loan for your property.
Life insurance companies, even provide loans to large purchases and whatnot, but those are gonna be not as attractive loan quotes because life insurance companies don't take on the same kind of risk that the banks do and so on and so forth. So depending on the size of your loan, there's going to be a myriad of choices. The smaller ones, again, the savings and loans and the local credit unions, the bigger ones, Fannie, Freddie Mac, and CMB Life Insurance.
Matt Faircloth @TheMattFaircloth (38:48.473)
Well, now, okay, Herve, now those are all for fixed rate, for fixed, likely fixed interest rate deals, deals we're gonna be going in. I mean, Fannie and Freddie are government backed agencies who are dedicated, their dedication is to provide and keep housing affordable in America, right? And so their rates are about as low as you're gonna get, non-recourse, not mean no personal guarantee required for most of the things you just listed, right? And that's all well and good. But, however, however.
I know they've fallen out of fashion these days, but these loans are going to be here forever and ever. These are loans that are for properties that need a little bit of work. If you're wearing a long sleeve shirt, you're going to have to roll those sleeves up because these are properties that are likely performing below 90% occupancy, that have a little more hair on them, so to speak, and that are going to need a lot more work, maybe a little more investment in construction to bring around to the promised land. You know what I'm saying? You will attest to that.
Go into something on this, and the nice way to call it is a bridge loan. A bridge is a lovely thing that you cross to go from where you're standing to where you want to go. And these bridge loans are on small deals, what you would call hard money. Or you might get a bank to provide a small short-term bridge to you, and they would lend you on your purchase price and on your construction.
And this is the way a lot of this industry was run for many, many years. Now, bridge loans have fallen out of fashion because they're floating rate, meaning like the interest rate is one thing one day and then literally tomorrow or next month or whatever it is, it's a different rate. In today's economy, interest rates have gone way up and so bridge loans have obviously gone way up as well in cost. That likely changes over time. Maybe rates come back down.
Matt Faircloth @TheMattFaircloth (40:44.125)
What's the end? You don't want to be in a bridge alone forever. The end game is you want to exit, right? So how do you do that? Yeah.
Herve Francois (40:50.118)
Absolutely. You want to exit and typically that exit is going to be able to be triggered if you will once you have done the renovations on your properties that has resulted in an increasing of the value of that property. Why are you so interested in increasing the value of that property? Besides providing a nice return to your investors and a nice place to live to your investors, transforming lives, but also to go ahead and put that property in a position to be refinanced by that lender in about two to three years.
What are you going to refinance to? Well, you're going to get out of that very expensive bridge loan debt, and you're going to refinance, convert to a much lower cost fixed rate debt for the remaining years that you're gonna be working on. And you can see.
Matt Faircloth @TheMattFaircloth (41:39.677)
Yeah. You can also sell too, by the way. I mean, if you've done what you're supposed to do, then you've implemented the business plan and pushed, maybe pushed revenue, dropped expenses, opened up the profitability on the deal, addressed some capital improvement issues, maybe replaced windows, replaced roof, dropped in some landscaping to make the property a bunch more appealing and more sustainable longer term. Maybe a new buyer might be willing to pay you top dollar based on your new financial performance you created in a resale and you could use a bridge debt loan to get you from A to B.
Again, guys, this is just a snapshot of today's current market. These loans have gotten way more expensive. They're going to come back down. I remember when bridge debt was just what people did and back in the day or day you were able to borrow at 75, 80% loan to value on purchase plus 100% of construction.
They can be very favorable. They're willing to put a lot of money into the deal if they see what the long-term business plan looks like. So guys, if you've got a deal that needs a lot of work, make sure you talk to your loan broker about what bridge programs are out there, short-term, long-term bridge, and how you could transition out. All those things get put into your underwriting model as well.
You better be using an underwriting tool that has the option for bridge in it and has the option for buying it on day one and then refinancing it on two years in after you've implemented that business plan, a good underwriting tool should be able to analyze all those things for you. So, Arvait, then the last component that goes in on top of where we are right now, we've got a good performer that's been trusted but verified, a good business plan on where we're taking the property, where we are now, where we want to go, right?
And what the cost to do that construction is going to be in the renovations, the new revenue streams and the new expense loads, what we're going to put on the property going to be and how we're going to finance all that, right? What's going to be with investor equity, it's going to be with debt coming from the bank, all that stuff. Then it goes back to what we had said before. The last component of the business plan is what is your exit? Right? It business, everything, all good things must come to an end, right?
So you got to conclude, this investment at some point with a refinance and then maybe a sale in the future or a reno and then a sale, right? How, when you're working with her underwriter, how do you determine what that exit looks like?
Herve Francois (44:11.242)
Mm, yeah, that's a great question, right? Now, this is when it becomes a little bit more art than science. Yeah, we're doing right. And we're making an estimate on the capitalization rate in the future of the year that we're going to be looking to go ahead and sell the property as to what we could potentially go ahead and sell the property for. Now, if we've done, if we have executed correctly on our business plan, then we would have increased the value of the property. And as such, you should see an increase in the capitalization rate, right? And whatnot, because you would have really inflated your NOI.
A lot of times, however, when it's time for you to prepare your underwriting and now you're presenting it to a loan broker or loan officer they actually want you to be very conservative in your underwriting as banks are conservative, right? From a risk reward basis. So they almost like to see a decline in that cap rate because they want to make sure that, again, you're being very, very conservative in the underwriting. So that is, I'm not gonna call it counterintuitive, but it's typically the opposite.
Yes, we are conservative in our underwriting. The banks want you to be even more conservative in the underwriting because it has to make sense for them that particular exit strategy.
Matt Faircloth @TheMattFaircloth (45:45.961)
Absolutely, absolutely. And whatever, guys, it also goes back to what your long-term business plan for your company is, right? You need to work with your partners and the other seats on the bus, so to speak, your hammer, your asset manager that's going to be implementing a lot of the plan that you came up with here, your money person to what they're telling the investors that you're going to be doing, and your hunter to determine where the long-term future of the market is. All those factors and conversations with your team are going to dictate, oh, guys, I'm
Are we talking two, three year hold here? We wanna get in, get out, provide a big bump in returns, maybe not lots of cash flow, but just a hopefully big bump in appreciation. What's our goals? What are we looking for? Are we looking for appreciation, cash flow, a little bit of both? I don't know. Those things will govern the end of the plan here, right? And as R.V. said, you wanna be conservative enough to protect, there's an art here, right? There's conservatism that you can put into your deal to make sure that you're safe.
And there's conservatism, you can put it into your deal to make sure you'll never do a deal. Right? So, right? You got to take a little bit of risk, but you also have to protect yourself and your investors. And that's what's great about the push-pull that happens in underwriting a little bit, which is why you can't allow your underwriter only. Underwriters, their mental wiring tends to be a little more on the conservative side. They tend to be a little more risk averse, right?
A little bit like, eh, we'll build the parachute on the way down. We'll just buy the property and figure it out. You need to have both personality types on your real estate team. If you don't, if you've got an underwriter that's so risk averse, like I said, they'll talk you out of every deal that ever shows up. Right? It's like, well, what if this, what if that, what if this? And you also have people like me and Herve that'll shoot the lights out. Right?
You need to have a good combination of the two. And that's what's great about a good underwriting tool will allow you to have a little bit of that push-pull to the point where you land at a place where there's still plenty of conservative mechanisms in to keep you safe. And there's also a little bit of aggressiveness to where you actually are able to grow and take down some opportunities, right? Good underwriting tool and a good push-pull on your team are gonna be able to do it, right?
Hervé, what are some of the, as we're bringing it home here, what are some of the biggest mistakes you've seen people make when they underwrite opportunities. Now you've worked with a lot of underwriters in your career and you've seen underwriters from some of our competitors. So help our listeners out here. What do we not want them to do? What are some mistakes that they could be making that we wanna stop them from doing right here?
Herve Francois (48:24.066)
But one of the biggest is that I've seen is people taking the current operating performance of that property and projecting it out over the next three to five, seven, 10 years, believing that the current occupancy at 95% today is going to continue to remain stable at 95% and then grow from there. That's one of the biggest mistakes that I make.
Oh, well that I see, oh, well, if it's operating like this right now, it should operate in the same manner within a couple of years. I couldn't see a bigger mistake, fallacy from the truth, to be honest with you. And it's because you have to be extremely, extremely careful. We are so conservative that it keeps us from doing deals, but we are conservative that, for example, what we at DeRosa do, we always underwrite to occupancy declining in the first year of ownership versus increasing.
It's not that we don't believe in ourselves in the executing of our business plan and our property manager and so on and so forth. It's simple because that we know that we have a renovation plan in place. And in so doing, there's some tenants, residents that are not gonna buy in and they're going to go ahead and choose to not renew their lease and walk away, right? And as such, we will gladly take over that unit to start the renovation. But when that happens, the occupancy starts to decline before it starts to increase. Another thing.
Matt Faircloth @TheMattFaircloth (49:48.773)
And there's a lot of times occupancy drop when the new sheriff shows up. If you're gonna be bringing in a new property manager, you're going to have a little bit of new sheriff in town to like, well, I'm not gonna stick around for this. So tenants are gonna move out. We found out the hard way that just occupancy tends to fall off at the change of your ownership for a little bit. And then there's a stabilization period that it takes even an occupancy to bring it back up. You have to plan for that, right? No.
Herve Francois (50:15.055)
Right. Absolutely. I would say a couple other mistakes, folks, that I see Matt making on the underwriting is on advertising and promotion. Now you may view this as very, very small in the grand scheme of things. When you take a look at all the Apex lines, operating expense items, advertising promotion is typically on the lower side, but the recent... No, no. After...
Matt Faircloth @TheMattFaircloth (50:34.957)
I can't just put it on Facebook for free? No? I can't do just Facebook marketplace ads for my vacant apartments? No? I gotta actually promote, huh? Okay. Huh.
Herve Francois (50:44.267)
You've made a plan to go ahead and renovate the properties. Well, it's a great plan. I have to renovate the units. I'm going to go ahead and increase the rents by 100 bucks, 200 bucks. Great plan, but how are you going to advertise that? How are you going to put that out? Now you have a more, let's say, competitive set out there in the marketplace relative to the comps out there. And now you need to go and attract residents to move into your newly renovated unit, versus the other options that they have out there. Because after renovation, you've made your property more competitive.
It's a good thing, but you made it more competitive. But now you need to get people attracted to come and live at your property. That's gonna take some advertising. That's gonna take some promotion. If it wasn't secure before, what did we do in regards to putting security cameras, LED lights around the property? Did we go ahead and underwrite carefully?
And listen, whether or not if we've made a mistake, and this is, I'll leave it here, one of the biggest mistakes also that I see people underwriting, understanding that you're not gonna have all your numbers airtight 100% correct, that there's a risk that you underestimated a particular expense, one of the biggest mistakes that I've seen is people not setting aside enough for operating expense reserves, set aside for operating expense reserves just in case. In case what, Herve? In case that happens. In case this happens.
Matt Faircloth @TheMattFaircloth (52:12.345)
Yeah. In case, in case, in case something happens and you know, something does, right?
Herve Francois (52:16.632)
I don't know, COVID-19 pandemic. Oh my gosh.
Matt Faircloth @TheMattFaircloth (52:19.777)
Yeah. Or just setting money aside, right? Because then I get you guys have a construction plan, renovation plan, that kind of thing. But it's important to set aside some dollar amount per unit per year for things like HVAC repairs, for things like roof patches, for things that are just major capital improvements to the site. You don't want to do all that out of the reserves that you've raised for the deal. You want to do some of that out of just set asides out of cashflow, right?
Herve Francois (52:46.306)
Right, right, absolutely, absolutely. So those are probably the three biggest mistakes that I see people make. They assume that current operating performance gets projected out. They underestimate for advertising promotion. And as well, they don't set aside any or very little for capital OPEX reserves.
Matt Faircloth @TheMattFaircloth (53:08.709)
Yeah. And guys, all of this plays into, hey, we haven't heard us talk about this yet. And that's because it's kind of like the last component, right? The underwriting tool that you're going to use is going to add up all these things. It's going to look at purchase price of the asset, the hopefully healthy operating reserve that you put in, don't be going in with like, you know, $2.25 enough to run the property, go in with a significant operating amount of cash for just in case.
That's just sitting there waiting for things to change in case you need it. Construction budget, all that stuff. All that goes into your underwriting tool, the Performa, all of it. It's going to spit out how much equity is left that you need to raise from your investors. You're going to take that to your money person. You sit down with your money person and say, okay, I need to raise X. It looks like if we hit our numbers and our well-thought-out business plan, it's going to produce a Y rate of return for those investors.
Here we go, those numbers don't work. Your underwriter should have some conservative levers that they can move. Well, if we can get the debt for a little bit less, or if we could raise the rents a little bit more, or if we could sell it for another 1% on the backend, maybe that's something that would help those investor returns. And those are assumptions that are safe to make. But the mistake you don't want to make is to model the deal to match investor returns, right? Meaning like putting investor returns first and saying, okay, I need to get to a 15% IRR, right?
And I have a deal. And so I'm now going to build my deal to be inside that IRR, meaning like I need to get rents from $800 to $1400 so I can make the IRR that I need to, or I need to do XYZ. The worst thing you can do is to build your deal based on an investor return. You want to look at that investor return last. You don't go in with it first because that'll cause you to be way less conservative than you probably should. It's okay for the deal not to work, right? Financially. I mean, just forgetting what year it is now for when people are listening to this, how many deals do we typically underwrite at DeRosa Group in one year's time on average?
Herve Francois (55:22.366)
Oh, how many in one year we underwrite, we underwrite close to between 90 to 95 deals per year. Yeah. Give or take, give or take. Yep.
Matt Faircloth @TheMattFaircloth (55:30.917)
Yeah. 99. I thought we were in the hundreds, but yeah. Yeah. But that's, and that's like deep dive underwriting. We also, we get access to a lot more than that, but think about that guys. You go from that to then the LOIs get submitted on a fraction of that and then those offers get accepted on a fraction of those LOIs. So at the end of the day, it's okay that you don't find a way to make every deal that comes across your desk work.
Underwriting is not about finding a way to make the deal work. Underwriting is about building a plan that's conservative enough that you guys are comfortable with it that matches your investor returns. And if that is the way you go into it, a lot of these deals are not going to price out based on what the seller is asking for. Let somebody else buy it. I want you guys to be in this business for decades, not a year. Be in this thing for the long game. The way we play the long game is by going with put those investor returns as the last thing that you look at. And if the deal doesn't work to meet investor returns, it just makes your underwriting muscles or is that much stronger for the next deal that comes up. Right, Hervé?
Herve Francois (56:35.234)
Absolutely, absolutely. No, it's just a matter of just planning. You wanna plan so you can play for tomorrow, right? In the next day, in the next day.
Matt Faircloth @TheMattFaircloth (56:46.845)
Guys, great conversation today. Herve, thank you. I hope you guys got a lot out of the underwriting conversation in this module, in this podcast. It's very important. It's probably, as I said, the unsung hero, the unsung part of the plan, but it's really where a lot of the success gets created is in well conservative, well thought out, just conservative, well thought out business plans. Right? Hope you guys enjoyed today's conversation.
Herve Francois (57:09.975)
Absolutely.
Matt Faircloth @TheMattFaircloth (57:16.765)
The underwriting tool that we've developed. You can consider one of our student programs that you guys could hear more about that at derosagroup.com forward slash best ever. Derosagroup.com forward slash best ever. And Derosa is D-E-R-O-S-A. You guys can grab a copy of Hervé's underwriting tool that he's developed that is a free asset you guys could pick up over there at that website. You guys can take our personality assessment that'll tell you which of the core four superpowers you are.
That's your that assessment will tell you those things and you guys want to hear more about our multifamily accelerator program That is also at that site for those that participate in the multifamily accelerator program Get access to our underwriting tools I'd said before and they also get direct involvement from the DeRosa team to help them 10x their business and take their Multifamily investment company to the next level Herve love chatting with you man. Appreciate you appreciate your conversations today. I hope this is a value for you listeners as well.
Herve Francois (58:09.358)
Thank you very much. Absolutely.
Have a great one. Thank you.
Matt Faircloth @TheMattFaircloth (58:13.957)
Cool. Thanks guys. Have a good one.