How to underwrite a multifamily deal
Worked end to end on a 120-unit building: the unit mix, the three deductions between gross rent and real revenue, the renovation ramp, and the cap rate all of it moves.
Start with the one structural difference
Every other asset class is underwritten off contracts. A retail or office rent roll is a set of multi-year leases with dates, steps and options, and the model is largely a question of reading them correctly.
An apartment rent roll is a snapshot. Leases run twelve months, so essentially the whole building re-prices within a year. There is no meaningful weighted average lease term to quote and no rollover schedule to cluster, because everything rolls, constantly.
That cuts both ways, and it is worth being honest about both. Income re-prices to market fast when rents are rising, which is the entire appeal. And when rents fall there is no contractual floor underneath you — nothing holds the income up while you wait.
It also changes the unit of account. You do not model 120 leases. You model a handful of unit types — sixty units of a two-bedroom plan at one average rent — and revenue is units multiplied by rent, never square feet multiplied by a rate.
A 120-unit deal, worked
Sample inputs
- Units
- 120
- Gross rent, annual
- $1,964,880
- Physical vacancy
- 8%
- Economic vacancy
- 2%
- Bad debt
- 1%
- Rent growth
- 3%/yr
- Operating expenses
- $744,000
- Asking price
- $18,500,000
A 1980s garden-style property, three unit types, two of which are unrenovated and are the reason anyone is interested. The seller is asking $18,500,000.
| Unit type | Units | Current rent | Renovated premium | Renovation pace |
|---|---|---|---|---|
| 1 Bed / 1 Bath | 48 | $1,150 | +$225 | 24/yr |
| 2 Bed / 2 Bath | 60 | $1,450 | +$275 | 24/yr |
| 3 Bed / 2 Bath | 12 | $1,795 | already renovated | — |
120 units at those rents is $1,964,880 a year of gross potential rent. That figure is correct, it is the sum of the rent column, and it is not revenue.
Three deductions, applied in order
Between gross rent and the money that reaches the bank sit three separate losses. They are different things and lenders treat them separately, so a model that blends them into one vacancy number cannot be checked against anything.
They compound rather than add. Each applies to what the one before it left, which is why the order is not cosmetic.
| Cost | Running total | |
|---|---|---|
| Gross potential rent | — | $1,964,880 |
| Less physical vacancy, 8% | $157,190 | $1,807,690 |
| Less economic vacancy, 2% | $36,154 | $1,771,536 |
| Less bad debt, 1% | $17,715 | $1,753,820 |
| Effective gross income | $211,060 in total | $1,753,820 |
Physical vacancy is units standing empty. Here 8%, which is the property today rather than the submarket.
Economic vacancy is occupied units not paying full rent — concessions, a free month, an employee unit, a tenant on a legacy rate. A building can be 100% physically occupied and still lose several points here, which is precisely why it is a separate line.
Bad debt is rent billed and never collected. It is the smallest of the three at $17,715 and the one most often left out entirely.
Together they cost $211,060 a year, 10.74% of gross rent. Effective gross income is $1,753,820.
What that does to the cap rate
Take $744,000 of operating expenses off effective gross income and NOI is $1,009,820. Against the $18,500,000 asking price that is a 5.458% cap rate.
Run the same expenses against gross potential rent instead — the error this page exists to prevent — and NOI comes out at $1,220,880 and the cap rate at 6.599%.
That is 114 basis points of daylight on one deal, and it is the difference between a property that clears most buyers’ thresholds and one that does not. Nothing about the building changed. Only whether three ordinary deductions were applied.
Then the renovation, which is slower than it sounds
The value-add case rests on three numbers, and the third is the one that gets skipped: how many units you can turn a year, what the renovated unit earns, and how long it sits empty while the work happens.
Twenty-four units a year sounds like half the building in two years. With two months of downtime on each one, the premium arrives materially later than the budget implies — a unit started in month 22 is earning nothing extra at month 24.
Model it properly and by month 24 effective gross income is $1,978,092. Grow the expenses too, at the same 3%, and they reach $789,310 — because taxes reassess after a sale, insurance has been climbing, and you do not hold payroll flat while pushing rents. NOI lands at $1,188,782, up 17.7%.
Held at the entry cap rate that income is worth $21.78 million against the $18.5 million paid. That is the deal, and it is a real one — but it took two years and it is a fraction of what the same arithmetic produces if you freeze expenses.
One fact worth keeping. It takes until month 24 for the revenue you actually collect to pass the gross rent figure printed on page one of the offering memorandum — by $13,212. Two years of renovation and rent growth to catch a number that was never revenue in the first place.
What to check before you believe a multifamily pro forma
- Is vacancy the property’s or the submarket’s? Using the market rate on a building running well above it books income that does not exist yet.
- Are concessions and bad debt shown at all? If the income section runs straight from gross rent to effective gross income with a single vacancy line, two of the three deductions are missing.
- Do expenses grow? Flat expenses against growing revenue is the single most common way a pro forma manufactures NOI.
- Is there renovation downtime? A premium that lands the month work starts is a spreadsheet, not a business plan.
- Has the tax bill been reassessed? In much of the country a sale triggers reassessment, and the seller’s tax line is the old basis.
- Is there a replacement reserve? Lenders will underwrite one whether or not the offering memorandum does.
Questions people ask
How is underwriting a multifamily deal different from office or retail?
The rent roll is a snapshot rather than a contract stream. Apartment leases run twelve months, so almost the entire building re-prices within a year, and there is no weighted average lease term worth quoting. That cuts both ways: income resets to market quickly when rents rise, and there is nothing holding it up when they fall. You also model unit types rather than suites — sixty units of a two-bedroom plan at one average rent, not sixty individually negotiated leases.
What is the difference between gross potential rent and effective gross income?
Gross potential rent is every unit full at its asking rent, which never happens. Effective gross income is what actually arrives after three deductions applied in order: physical vacancy for empty units, economic vacancy or concessions for occupied units not paying full rent, and bad debt for rent billed and never collected. They compound rather than sum, because each applies to what the previous one left.
What vacancy rate should I underwrite?
Use the property's actual current vacancy as the starting point and the submarket's stabilized rate as the destination, with an explicit number of months between them. A single blended figure hides the question that matters, which is how long the gap takes to close and what the income looks like while it does. Lenders will size the loan on the stabilized number and fund on the current one.
How do I underwrite a value-add renovation?
Three inputs, and the third is the one people skip: how many units you can turn per year, how much rent the renovated unit earns, and how long the unit sits empty between tenants while the work happens. Downtime is what separates a plan on paper from the cash flow it produces. A budget of twenty-four units a year with two months of downtime each does not deliver the full premium until well into year three.
Do operating expenses grow in a value-add model?
They should, and holding them flat is the most common way a value-add pro forma flatters itself. Taxes usually reassess after a sale, insurance has been rising faster than general inflation across most of the country, and payroll and turnover costs go up with the rent you are pushing. Growing revenue while freezing expenses manufactures NOI that will not appear.
What does DealWise AI do for a multifamily deal?
You upload the offering memorandum, the rent roll and the operating statement. It reads them, builds the unit mix, applies the loss factors in the right order and models every month of the hold including the renovation ramp and its downtime. The stated cap rate is captured and displayed but never used as an input, so you can see the gap between what the seller claims and what the unit mix actually supports. Free plan, one complete deal.
Keep reading
What is NOI?
The figure everything else on this page is derived from.
What is cap rate?
What the 114 basis points on this page actually cost a buyer.
Underwriting, generally
The process that applies across all four asset classes.
What is a rent roll?
The document the whole model is built from.
Break-even occupancy
How empty the building can get before it stops covering its bills.
Value it
What an NOI is worth at a cap rate you believe. Free, no signup.
Stop rebuilding the same apartment model.
Upload the offering memorandum, the rent roll and the operating statement. DealWise reads them, builds the unit mix, applies the loss factors in the right order and models every month of the hold — renovation downtime included. Free plan, no credit card.