3 Things New Multifamily Investors Miss [& Why They Matter]

Multifamily is one of the most popular asset classes in commercial real estate, in large part because it’s very understandable.

While most people haven’t signed a 5-year restaurant lease or committed to an office space for their company, most people have rented an apartment and can wrap their heads around these properties.

But even though the multifamily asset class might seem straightforward, there are a few things that newer analysts and investors often miss when underwriting multifamily deals. And in this post, we’ll cover three of the biggest things I learned to look for when working for one of the largest multifamily investment firms in the US, and how each of these things can impact a real estate investment.

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Understanding the T-12 and Rent Roll

All of the things we’ll talk about in this post are specifically related to what are referred to as the T-12 and the rent roll, which are both heavily used during the underwriting process.

What Is a T-12?

“T-12” is short for trailing 12 months, and this represents a seller’s profit and loss statement over the last year.

What Is a Rent Roll?

A rent roll is a detailed list of all units at a property, including the base rent each unit is generating, any other monthly charges being applied, and the start and end dates of each lease.

All of these things can have a direct impact on the net operating income a property generates, which will directly affect not only the cash flows an investor can generate, but also the value of the property.

When it comes to analyzing deals and making future cash flow and value projections, both the rent roll and the T-12 need to be analyzed very carefully. And for newer investors or first-time analysts, there are a few things to look out for that are very easy to miss.

#1: Bad Debt

Aside from general revenue and expenses, the first thing you’ll want to put on your radar when underwriting a multifamily deal is the amount of bad debt incurred at the property.

What Is Bad Debt?

Bad debt refers to rent payments owed that have been written off by a property owner and aren’t expected to be collected, as a result of tenants failing to pay the landlord the total rent that was due.

Expected Ranges by Property Class

In most cases, multifamily properties will have bad debt that ranges anywhere from about 0.25% up to ~3% of the total rent owed. And while this might seem insignificant, this can have some major impacts on the total revenue generated by a multifamily investor, and ultimately the value of a property overall.

For Class A properties in prime locations with top-of-market rents, you can typically expect this number to be on the low end of this range.

For Class B properties in more secondary, suburban locations, you can usually expect this number to be in the middle of this range.

And for Class C properties in more tertiary, lower-income areas, it’s not uncommon to see bad debt on the high end of this range (or even above it).

Related Line Items to Watch

Other similar line items to look for that can provide insight into collections issues include late fees, cleaning fees, and forfeited deposits. Each of these things can give you a really good indication of when (or if) tenants are paying, and how they’re treating the units they live in.

The key takeaway here is that even if you add up all the base rent on a rent roll, this doesn’t automatically translate into how much rent you would actually collect as the owner of the property, and making sure you’re keeping a very close eye on bad debt and collections issues is absolutely critical when underwriting deals.

#2: Concessions

Continuing on the rent side of things, the next line item to focus on that can have a huge impact on total income is concessions.

What Are Concessions?

Concessions are incentives or discounts offered by property owners to attract or retain tenants. On multifamily properties, these typically come in the form of one to three months of free rent.

And again, just like bad debt, a lot of concessions can make the rent roll show a very different total rent number than the total rent an investor could reasonably expect to generate over a 12-month period without these concessions in place.

Net Effective Rent

Because of this, multifamily investors will often focus on what’s referred to as the net effective rent, which factors in these concessions and provides a clear snapshot of the average monthly rent a tenant is paying throughout their entire lease term.

For example, let’s say a tenant signs a 12-month lease at $3,000/month, but gets the first month of that 12-month lease free. In this case, their net effective rent would be calculated by taking the total rent they’re required to pay over their entire 12-month lease term ($33,000) and dividing that by 12, which equals just $2,750 per month.

This net effective rent figure is much more indicative of what tenants are actually willing to pay to rent a unit, and the kind of monthly rents you can expect to generate without those concessions in place.

You’ll often see a lot of concessions on properties that are broadly marketed for sale, because sellers and brokers know this is often missed by potential buyers who are looking only at the rent roll and base rent values.

The key takeaway here is that when you’re analyzing a deal, if concessions have been offered over the last year, and the seller has been offering one month of free rent on both new and renewal leases during that time, it’s very likely that the rent roll you’re provided represents a number that’s almost 10% higher than the net effective monthly rents you’d end up collecting collect throughout the next 12-months.

#3: Deferred Maintenance

Unlike the last two line items we talked about, the final thing I want to mention in this post is related to the costs associated with owning a property, and this is to look for any major spikes in operating expenses that could signal deferred maintenance.

Unexpected capital costs can be a huge drag on investment returns, and when big increases in operating expenses show up on a T-12, this can be a really big indicator that something might be off.

Some of the biggest expense line items where this might be an issue are:

• HVAC costs
• Electrical costs
• Plumbing costs
• Roof repairs

If you’re seeing big spikes in any of these (especially if these are happening often), these could represent band-aid repairs that are covering up a bigger issue.

These are often things that can completely blow up a pro forma, like major leaks or pipe bursts, fires related to outdated electrical systems, or heating and cooling problems that are extremely costly to fix.

And unlike common area or unit interior renovations, where you’re making the property a nicer place to live, functional plumbing, electrical, and HVAC systems are all things that residents expect, and tenants won’t pay a premium for basic utilities working correctly.

High expenses in these categories usually tell a story of what investors refer to as “deferred maintenance,” or big repairs that the seller has put off in hopes that the next buyer would take on that burden.

When you see a lot of these expense spikes within a seller’s financials, these are things that either need to be looked at more closely by your general contractor or in a property condition assessment report, or things that can even make it worth passing on a deal altogether.

How To Learn More About Multifamily Investment Analysis

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