Answers
Underwriting, explained
The questions that come up on every deal, answered properly. No gated downloads and no sign-up. Each page opens with the whole answer and then shows the work.
- What is a T-12 in real estate?A T-12 is a trailing twelve month operating statement: every income and expense line a property actually produced over the last twelve months, almost always presented as twelve monthly columns with an annual total. Buyers ask for it because it is the one document in a deal package that reports what happened rather than what the seller projects. Underwriting starts by normalizing it, which means restating the seller's expenses at what they will cost under your ownership.
- How do you read a rent roll?A rent roll is a snapshot of what is leased right now: unit by unit for residential, tenant by tenant for commercial, showing who occupies the space, at what rent, and until when. Read it for three things. What is actually being collected today, how far that sits from market, and when each lease rolls.
- How do you calculate net operating income (NOI)?Net operating income is effective gross income minus operating expenses. Effective gross income is gross potential rent less vacancy, concessions and credit loss, plus other income. The arithmetic is trivial; the difficulty is deciding which lines count as operating expenses, because debt service, capital expenditure, tenant improvements, leasing commissions, depreciation and income taxes are all excluded by definition.
- How do lenders size a commercial real estate loan?A lender runs three independent tests and lends the smallest result. A loan-to-value cap limits the loan to a percentage of appraised value. A minimum debt service coverage ratio limits it to the debt the property's net operating income can service, usually tested at a stressed rate. A debt yield floor limits it to net operating income divided by a required yield. Which of the three binds tells you more about the market than any single ratio does.
- Cap rate, cash-on-cash, or IRR: which return metric should you use?They answer three different questions, so the choice is not between them. A cap rate prices the asset unlevered at a single moment: net operating income divided by value. Cash-on-cash measures one year of levered cash flow against the equity invested. Internal rate of return measures the entire hold including the sale, weighted by when each dollar arrives. Read together with the equity multiple they describe a deal; read alone, each one is easy to game.
- How does a real estate distribution waterfall work?A distribution waterfall is the order in which cash from a property is split between the limited partners who funded it and the general partner who runs it. The common sequence pays a preferred return on limited partner capital first, then returns that capital, then splits whatever remains on terms that favor the general partner. That disproportionate share of the remainder is the promote, and it is the sponsor's actual compensation for performance.
- How do you model lease rollover, TI and LC in office and retail?Model each tenant on its own expiration, not on a portfolio average. At every roll date decide the market rent, a renewal probability, and the capital each outcome requires: renewal terms with a lower tenant improvement allowance and a shorter downtime, or a new lease with a higher allowance, a full leasing commission, and months of vacancy before rent restarts. The blended result of those two outcomes is the cash flow. The capital is usually what decides the deal.
- How should you read an offering memorandum?An offering memorandum is the seller's marketing document. It is usually the best available summary of the asset and the least reliable set of forward numbers in the package, because the pro forma inside it is an argument rather than an underwriting. Read the exhibits first, build your own year one from the rent roll and the T-12, and treat the narrative as a source of questions rather than answers.
- What does real estate underwriting software actually do?Real estate underwriting software turns a deal's source documents into a financial model and the documents an investment committee reads. Four jobs sit inside that: extracting figures from an offering memorandum, rent roll and operating statement; computing a cash flow, debt structure and return set correctly; letting an analyst change any assumption and see everything recompute; and producing an Excel workbook and a memo that reconcile to the model. A tool that does three of the four sends you back to a spreadsheet.
- How much does ARGUS cost?Altus Group does not publish a price list for ARGUS Enterprise, so no official figure exists to quote: you request a quote and it is negotiated per firm. Every number that circulates on third-party directories and industry forums is second-hand, and those numbers contradict each other, from a few thousand dollars per user per year at the low end to several times that at the high end, with one-time implementation and training commonly cited in the five-figure range. Seats, modules and contract term are what drive a quote, so the only figure worth budgeting against is the one Altus puts in writing for your firm.
Try it on the deal on your desk
Drop in an offering memorandum and a rent roll.