How We Underwrite: What Conservative Actually Means

Conservative underwriting is one of the most abused phrases in real estate. Every deal sponsor uses it. Almost none of them mean the same thing by it. When most operators say conservative, they mean they projected 3% rent growth instead of 5%. What they did not stress test is the vacancy spike, the rate environment, the exit cap expansion, or the capex overrun.

Here is what conservative underwriting actually looks like in our process.

Step One: Start With T-12, Not Pro Forma

Every underwriting starts with the trailing 12-month financials from the current operator, not the broker's pro forma. The T-12 tells us what the asset is actually doing. The pro forma tells us what someone wants us to believe it could do. We build our model from reality, then layer in a defensible value-add thesis on top.

If a broker provides only a pro forma and delays on the T-12, that is a data point about the deal.

Step Two: Stress the Vacancy

We underwrite to 10% vacancy as our base case for value-add assets, regardless of in-place occupancy at acquisition. We then stress test to 15% and confirm the deal still covers debt service. If it does not cover debt service at 15% vacancy, we either need different debt terms or we pass.

Most sponsors underwrite to 5% or 7% vacancy because that is what the market looks like at acquisition. That is not stress testing. That is optimism with a spreadsheet.

Step Three: Use Current Debt, Not Future Hope

We underwrite to current interest rates plus 50 basis points. We do not assume rate decreases. If rates drop during the hold, that is upside. If they do not, the deal still works. Bridge debt gets underwritten with the assumption that the refinance rate at stabilization is equal to or higher than today.

Step Four: Model a Flat Exit

Our base case exit assumes the cap rate at disposition equals the cap rate at acquisition. We do not underwrite cap rate compression as a return driver. If compression happens, that is upside. If it does not, or if cap rates expand 25 basis points, the return target should still be achievable through operational NOI growth alone.

If a deal only works with cap rate compression baked into the base case, we do not do the deal.

Step Five: Buffer the Capital Budget

Whatever the contractor quotes for value-add capital improvements, we add 20%. Capital projects in occupied multifamily assets always take longer and cost more than projected. Budget accordingly before the deal is closed, not after the reserves run out.

The Result

A deal underwritten this way will look less attractive on paper than a deal built on optimistic assumptions. The IRR in our base case will be lower than what a more aggressive sponsor projects. That is intentional. We would rather show you a realistic 14% than an optimistic 22% that requires everything to go right.

Our job is not to show you the best case. It is to show you the realistic case, so you can make an informed decision about whether you want to deploy capital alongside us.