The assumptions that break deals, ranked

Having gone through a great many deals that disappointed, the errors are consistent enough to rank.

One: capital expenditure omitted or understated

The largest and most common.

A pro forma showing three percent of gross rent for capital, on a building with a twenty-year-old roof and original mechanicals, is describing a property that does not exist.

The correct figure on older property is frequently fifteen to twenty-five percent of gross rent, derived from a system-by-system inventory rather than a percentage.

The error is invisible for two or three years, then arrives as a single large bill that consumes several years of accumulated cash flow.

Two: property taxes at the seller's figure

In reassessment-on-transfer jurisdictions, the post-sale tax bill can be dramatically higher than the seller's.

This is entirely knowable in twenty minutes from the assessor's office and it is skipped constantly.

On a small property it can eliminate the entire projected cash flow.

Three: insurance at a historical figure

Recently promoted into the top tier of errors.

Premiums in exposed markets have moved by multiples, deductible structures have changed, and coverage has narrowed. The seller's premium tells you nothing.

Quote it during due diligence, on the coverage you will carry, with the property's claims history.

Four: management omitted

Self-managing investors leave this out and thereby overstate returns by eight to ten percent of gross rent.

Include it whether or not you will hire someone. A deal that only works with free labor is a job.

Five: exit cap rate compression

In any model with a projected sale, assuming the exit cap is lower than the entry cap is forecasting a more favorable market at an unknown future date.

It inflates projected IRR substantially and it is entirely unsupported.

Model the exit at or above the entry cap.

Six: rent growth above the historical record

Compounded over a hold period, the difference between three percent and five percent is enormous.

Check the assumption against the market's actual long-run rent history and against local wage growth, which is the eventual constraint.

And check whether rent regulation caps it, because in a growing number of jurisdictions it does.

Seven: pro forma rents treated as achievable now

Loss to lease is presented as guaranteed upside. Capturing it requires turnover or renewal increases, takes time, costs money, and may be legally restricted.

Underwrite partial capture over a realistic period, with the turnover cost included.

Eight: turnover cost excluded

Investors include a vacancy percentage and omit the actual cost of each turnover, which is the larger number — cleaning, painting, repairs, marketing, screening and leasing fees.

Frequently $2,000 to $4,000 per turnover on a modest unit, before the lost rent.

Nine: the refinance assumed to be available

The error that produced most of the distress of recent years.

A balloon maturing into a higher-rate environment supports a smaller loan, because sizing is a function of the payment. The shortfall must be funded with equity.

Model the refinance at rates several points above today's, and know the shortfall if the answer is bad.

Ten: renovation cost and timeline

Both wrong, both in the same direction, consistently.

Twenty percent contingency on older buildings, and a schedule fifty percent longer than the contractor's estimate, is the realistic starting point.

Eleven: vacancy at an aspirational rate

Three percent vacancy is not a submarket assumption, it is a hope. Use the actual submarket figure, and check what is under construction that will compete.

Twelve: reserves treated as optional

Not a modelling error exactly, and it converts survivable problems into forced sales.

Reserves after closing are part of the capital requirement, not something to fund later out of cash flow.

The pattern

Every error on this list moves the deal in the same direction, which is not coincidence.

Underwriting is done by someone who wants the deal to work, using numbers supplied by someone who wants it to work. The pressure is one-directional.

The defense is procedural rather than analytical.

Write the assumptions down before seeing the asking price. Verify every expense from an independent source. Note any assumption you revise, and why. Build the stress case before the emotional commitment.

And accept that most deals should be declined. An investor rejecting nineteen of twenty properties is not being difficult. They are doing the job.

General information about real estate underwriting, not investment advice. Verify all figures independently for any specific property. Consult qualified professionals about your own circumstances.