The Basics of Underwriting Your First Commercial Real Estate Investment

okay so in my last video we talked about the five absolute basics to getting into commercial real estate the first one of those was to get a job in commercial real estate that's the easiest way to learn check out this video here where i talk about how to get a job in the industry if you've been trying to break in you probably know how difficult it can actually be to find a job so we give you some tips there and also some different jobs that you could look into but number two on that list was underwriting commercial real estate learning how to properly financially analyze a deal so today i'm going to break down what underwriting is why it's important and how to go about doing it for your next project so underwriting comes from the latin term just kidding we don't care about any of that we're just going to talk about what it is underwriting is a financial analysis of a property you look at all of the numbers break them down from your purchase price and your down payment all the way to how much rent you're collecting every month what your vacancy rate is any interest expenses or operating expenses you have on the property and then you can even break it out into how much you're paying to your investors and how much you're paying to yourself that's essentially what underwriting takes into account it's all of the financials within a project now these are of course going to be projections going into it because you don't necessarily know what you're going to collect in three years in rent but you will have historical data hopefully from the seller or you can at least find yourself to say okay well taxes in 2020 were x and you know my insurance agent says that insurance on the property is going to be why so you can at least get a pretty good idea of what the project is going to return to you i see a lot of rookies make this mistake they just jump into a deal and say oh well i'll put you know 20 down and we're getting you know 2 000 a month in rent i've got to pay the bank x and this is how much i'm going to make every month and that's not really true at all there are a lot of expenses when it comes to operating these properties so when you look at a deal and say oh a 7 cap looks pretty good you might actually dive into it after financing and after all the operating expenses and you're losing money but you could also find another project that's a seven cap where you make a ton of money it totally depends on the lease structures and all the expenses on the property so underwriting is very important in commercial real estate because you need to know your numbers backwards and forwards because not only will the bank expect you to know that but so will your investors if you're taking any on and look we're not here buying buildings for our own health right at the end of the day we are trying to make money these are investments you think about the stock market and how many news channels and online resources there are telling you which stocks to buy which stocks not to buy why you should invest in this company what the forecast is going to be for you know this corporation and where their stock is going to be in five years you need to do the same thing for your projects take them just as seriously as an investment firm does when they're looking at which stocks to buy now you can get incredibly complicated when it comes to underwriting even taking into account the chances of a big corporation coming to your city and changing the rental rates and you know what what could that look like if you stress test the deal now we don't need to get that complicated in this video today we're just going to break down what i think every beginner investor should be doing at a minimum which is your back of napkin numbers now we actually have a spreadsheet for sale on my website where you can actually get a pre-made spreadsheet that has the most common expenses that we see when we're underwriting back of napkin on these deals you could also throw your own together if you know how to work on excel so we just did that to make it a little bit easier on you so that you don't have to spend 30 minutes setting up your own sheet but if you don't there it is available on the website so this spreadsheet is very basic like i said it's back of napkin it is intended for us to look at a deal and within five to ten minutes know whether we should be spending two weeks underwriting it because if you're properly underwriting a deal it's going to take a long time because when you're looking at these bigger commercial deals you've got to talk to contractors and figure out how much it's going to cost to renovate so i mean honestly in that scenario two weeks is not nearly long enough to properly underwrite a deal and we'll just use projections based off of past experiences but it can take a long time to actually go through the full underwriting process to create a spreadsheet that you would feel comfortable sharing with your equity investors and with your winner because your lender is probably going to want to see how you've underwritten the deal and how you've come to the conclusions that you have on the cash flow and the debt service coverage ratio that you'll get so this spreadsheet takes into account your income so rent you could also add in another line if you want to add in additional rent sometimes you've got a property that maybe you've got a you know drink machine outside right so there would be additional income coming in there that's not necessarily rent that you would probably want to add into your underwriting so you're taking into account the total amount of money you're collecting every month after that we have all of our expenses so everything from insurance to interest expenses common area maintenance property management we've got utilities taxes and then it aggregates everything into your total expenses so you know okay well every month we're spending approximately x or we at least need to be budgeting for x every month because some of your expenses you're not going to pay on a monthly basis you'll pay them annually but i always recommend at least just taking that out every month so you don't really see it too much at the end of the year when you've got to write that check from there you'll get your net income your monthly cash flow and your cash flow before debt service as well as your debt service coverage ratio most banks will want to see that you're at a 1.2 or 1.25 debt service coverage ratio so that's why we threw those two numbers in here i don't need to know my cash on cash return at this moment because i don't even know how i'm going to structure the deal with my investors i need to know if a bank is going to land on this project first so in this example that we threw together it looks like a 1.03 debt service coverage ratio so obviously i wouldn't even bother underwriting that further because i know for a fact that a bank will not win on it unless i throw in so much money and equity which is way more expensive than debt to get it to a 1.2 or 1.25 debt service coverage ratio that it wouldn't even be worth looking at this deal so as you can see our back of napkin underwriting is relatively straightforward it doesn't need to be all that complex and you can actually tailor these spreadsheets to show you the exact numbers that you need to see maybe you're not really concerned about the debt service coverage ratio because you're not taking out a loan and the cash on cash return is more important to you because you're paying all cash that could be your back of napkin metric or should we just go for a debt service coverage ratio because i know that i will be putting debt on the property after that point we will then take it into our other underwriting models which are far more intense and like i said they take a long while to actually dive into and fill out all of the numbers and those are the spreadsheets that we will end up presenting to our equity into our banks to show them you know hey here's the internal rate of return here's why you should give us capital and here is how secure this is as an investment so winder you should give us some money now we do have another live stream where i dive even further into the underwriting process using one of my more complex models click this video right here if you want to dive into that and learn a little bit more about modeling commercial real estate [Music]

Channel: Tyler Cauble

Views: 22,250

Keywords: commercial real estate, commercial real estate investing, real estate investing, buying commercial real estate, passive income, passive investments, underwriting, what is underwriting, underwriting meaning, mortgage process, mortgage underwriting, first time home buyer, underwriting explanation, underwriter, mortgage underwriting process, underwriting process mortgage, underwriting process, underwriting commercial real estate, break into cre, commercial real estate loans

Id: xhtLOctYCxY

Length: 7min 42sec (462 seconds)

Published: Tue Dec 14 2021