How to underwrite a multifamily deal from an offering memorandum

An offering memorandum is a sales document. That is not an accusation. A broker is paid to present the property in its best defensible light, and a good OM earns its keep: it has the rent roll, the trailing financials, the unit mix, the capital history, and a coherent story about why the asset is worth more under new ownership. What it is not is an underwriting. The pro forma at the back is the seller's answer to a question you have not asked yet.

The job is to rebuild the income statement from the primary documents, decide which of the seller's assumptions you actually believe, and then find out what the deal is worth to you, at your cost of capital, with the debt you can actually get. Here is the order that works.

Read the package in the order the OM does not present it

An OM leads with the story and buries the evidence. Invert it. Open the rent roll first, the trailing twelve second, the capital expenditure history third, and the marketing narrative last. By the time you read the seller's rent growth assumption you should already have your own, built from the roll, and the only question left is why the two disagree.

The documents you need are almost always in the package or one email away:

• The current rent roll, unit by unit, with lease start and end dates, in-place rent, market or asking rent, concessions, and status (occupied, notice, vacant, down, model, employee).
• The T-12, ideally with the twelve monthly columns rather than only the annual total.
• A T-3 or T-6 if the property has been through a renovation or a lease-up.
• The capital expenditure history, so you know what has already been replaced and what has not.
• The current property tax bill and the insurance declarations page, not the amounts in the T-12.
• Any loan quote or assumable debt terms.

If the rent roll and the T-12 do not arrive together, ask again before you model anything. One without the other is not enough to catch the mistakes that matter.

The rent roll is the primary document

Everything upstream of net operating income starts here. From the roll you can compute, without trusting a single number the OM asserted:

• Physical occupancy, as occupied units divided by total units. Count down units and model units honestly. A 60-unit property with two down for renovation and one model is running 57 revenue-capable units, not 60.
• Average in-place rent, weighted by unit, not the simple average of the unit-type table.
• Loss to lease, as the gap between in-place rent and the market rent the roll itself quotes. This is the single number a value-add story lives on, and it is the easiest one to inflate, because the "market rent" column is whatever the owner typed.
• Lease expiration exposure, month by month. Twelve leases expiring in the same 60 days is a real risk in a soft quarter, and it never appears in an annual pro forma.
• Concessions, which the roll often shows as a separate column and the T-12 often nets into revenue. Read both.

Take one number seriously here: verify the roll's market rent against something outside the package. If the OM says market rent is $1,675 and the comparable properties two blocks away are asking $1,575, the entire mark-to-market thesis is off by about 6%. On 60 units that is $72,000 a year of gross rent, and once you take vacancy and the management fee out of it, roughly $1.2 million of value at a 5.5% cap.

Rebuild effective gross income line by line

Work top down, and keep every deduction visible rather than collapsing them into one "vacancy" plug. A 60-unit example, using round numbers to keep the arithmetic legible:

Two things to watch in that table.

First, economic occupancy is not physical occupancy. Physical occupancy asks how many units have a body in them. Economic occupancy asks how much of gross potential rent actually reached the bank account, and it is always lower, because it absorbs concessions, bad debt, non-revenue units, and the gap between the roll's asking rent and what a signed lease actually pays. A property can be 96% physically occupied and 89% economically occupied, and only the second number pays the mortgage.

Second, other income deserves its own diligence. Utility reimbursement billing, parking, pet rent, storage, and application fees are real and recurring. A one-time legal settlement, a bulk cable rebate that has since been renegotiated, or an insurance proceeds credit is not. If other income is more than about a tenth of effective gross income, find out exactly what is in it before you grow it.

Normalize the expenses, then add the ones the seller does not have

The T-12 shows what the property cost the current owner. It does not show what it will cost you. The recurring adjustments, roughly in order of how much money they move:

• Real estate taxes. In many jurisdictions a sale triggers a reassessment, and the trailing tax line reflects an assessed value set years ago at a lower basis. Underwrite year one taxes on your purchase price at the current millage, not on the seller's bill. In a state with a transfer-triggered reassessment this single line can move net operating income by more than every other adjustment combined.
• Insurance. The trailing premium was set at the last renewal. Get a quote. In a hardening market a premium can reprice on renewal by a margin that swamps your entire rent growth assumption.
• Management fee. Almost always a percentage of effective gross income. An owner who self-manages may show zero or a token amount. Underwrite the fee in your actual management agreement, and underwrite it on your effective gross income, not the seller's.
• Payroll. On a portfolio, on-site staff are frequently allocated across several assets. Ask how many full-time equivalents actually sit at this property.
• Replacement reserves. Almost never in a seller's T-12, always required by a lender, and always required by reality. Reserve per unit per year is a negotiation with your lender, not a constant, but underwriting zero is underwriting a fiction.

Then compare the normalized expense load two ways: as a ratio to effective gross income, and as dollars per unit per year. The ratio catches structural problems. The per-unit figure catches a property whose expenses look fine only because its rents are high. If either lands far outside the range for the submarket and vintage, you have either found something or missed something, and both are worth an hour.

Altyst reads the rent roll and the T-12 and ties the two against each other. Where the stated net operating income will not reconcile with the rent and expense lines it is supposedly built from, the figures involved come back with lowered confidence and a note about what does not add up, which is where the unit-of-measure mistakes hide.

Your basis is not the asking price

Going-in cap rate is net operating income divided by total basis, not by the purchase price. Basis includes capitalized closing costs, the acquisition fee if there is one, and any day-one capital you have to spend before the property performs. On a $10,000,000 purchase with 1.5% in closing costs, $550,000 of net operating income is a 5.50% cap on price and a 5.42% cap on basis. That 8 basis points is small. On a deal with a $1,200,000 renovation budget it is not small at all, and quoting the cap on price is how a sponsor accidentally overstates yield to an investment committee.

The same applies to yield on cost in a value-add: the denominator is everything you will have put in by stabilization, including the capital you spend in year two.

Let the debt size itself

Never start from the loan amount you want. Size the loan three ways and take the smallest, because that is what a lender will do:

1. Loan to value. At 65% of a $10,000,000 value, $6,500,000.
2. Debt service coverage. At a 6.0% rate on a 30-year amortization schedule, the annual constant is about 7.19%. A 1.25x minimum coverage on $550,000 of net operating income allows $440,000 of annual debt service, which supports about $6,115,000.
3. Debt yield. At a 9.0% floor, $550,000 of net operating income supports about $6,111,000.

Debt yield binds, at roughly $6,111,000. Note what happened: the LTV test, the one most sponsors quote, was the loosest of the three and never mattered. Note also the second thing those three numbers are telling you. The loan constant is 7.19% and the going-in cap rate is 5.50%. That is negative leverage: the debt costs more than the asset yields on day one, so borrowing more lowers your going-in cash return rather than raising it. Negative leverage is not automatically disqualifying, and in a low-cap market it is common, but it means every dollar of return is coming from growth and exit rather than from current income, and you should say so out loud rather than let a levered internal rate of return hide it.

While you are here, compute break-even occupancy: operating expenses plus debt service, divided by gross potential rent plus other income. In this example that is $559,040 of expenses plus about $440,000 of debt service, over $1,176,000 of potential revenue, or roughly 85%. That is your margin of safety expressed in a form a lender and a partner both understand instantly.

The exit assumption is doing most of the work

In a five-year hold on a levered deal, the reversion is usually well over half of the total return. Which means the exit cap rate, a number nobody can know, is the single largest driver of an answer you are about to present as precise.

Two disciplines help.

Capitalize forward net operating income. The buyer in year five is pricing year six income, not year five income. Growing $550,000 at 3% for five years gives $619,030 in year five and $637,601 in year six. At a 5.75% exit cap that is a value of about $11,089,000, and after a 2% cost of sale, roughly $10,867,000 of gross proceeds. On a $10,150,000 basis, that is a thin gain, and the deal has to earn its return from cash flow and from executing the mark-to-market, not from the sale.

Expand the exit cap above the going-in cap. The property is five years older and the market may not be. Holding the exit equal to the entry cap is an assumption that the world stays exactly where it is, which is a forecast, not a base case. A common house rule is to set the exit at least 25 basis points wider than going in, and it is a good default even when nobody is making you do it.

Stress it before you believe it

A single-point answer is not an underwriting. Before the deal goes anywhere, run at least these:

• Exit cap plus 50 and plus 100 basis points.
• Rent growth at zero for the first two years.
• The renovation premium at half of what the seller achieved.
• Interest rate up 100 basis points at refinance or on the floating tranche.
• A two-way sensitivity grid on exit cap against rent growth, because those two are correlated in the real world and a one-at-a-time sweep will understate the downside.

What you are looking for is the point where the deal stops working, and how far away it is from your base case. Get a feel for the units first. At a 5.75% exit cap, a quarter point of expansion takes about 4% off the exit value, and at 65% leverage that 4% is roughly 12% of your equity. If the deal only clears your hurdle while the exit cap sits exactly where the entry cap sits, it is a bet on cap rates wearing a value-add costume.

The order of operations, compressed

1. Rent roll: occupancy, weighted in-place rent, loss to lease, expiration schedule.
2. T-12: normalize to a forward-looking expense run rate.
3. Reset taxes to your basis, insurance to a live quote, management to your contract, and add reserves.
4. Build effective gross income and net operating income with every deduction visible.
5. Compute the going-in cap on total basis, not on price.
6. Size debt on LTV, coverage, and debt yield, and take the binding constraint.
7. Check for negative leverage and compute break-even occupancy.
8. Set the exit on forward net operating income at a cap wider than going in.
9. Stress the exit, the growth, and the rate, together and not one at a time.
10. Write down, in one sentence, which assumption the return depends on most.

That last step is the one people skip, and it is the one an investment committee will ask about first. If you cannot name the assumption carrying the deal, you have not underwritten it yet. You have recalculated the OM.

Altyst runs this whole sequence from the documents you already have. Extraction proposes the values with their source and confidence, a deterministic engine does every calculation, and the model recomputes end to end the moment you change an assumption. See it on a sample deal.