Underwriting – Real Estate Guide


What is underwriting in real estate?

Underwriting is what lenders use the process of evaluating the financial and credit worthiness of a borrower relative to the real estate project. This helps lenders determine the level of risk exposure when lending to borrowers

What is analyzed during the borrower underwriting process?

Underwriters are analyzing the borrowers last two years of tax returns, last 3 months of bank statements for all retirement, investment, saving, and checking accounts, personal financial statements, and credit reports. The underwriter does this to find the borrowers liquidity, net worth, adjusted net worth, liabilities, and numerous ratios such as he debt-service coverage ratio (DSCR). The DSCR measures a borrower’s ability to meet their debt obligations. Real estate lenders typically require a minimum DSCR of 1.25. What does a DSCR of 1.25 mean? This means that the borrower can meet his debt obligations 1.25 times based on his current income.

What is analyzed during the project underwriting process?

Underwriters are analyzing the borrowers proforma in comparison to the appraisals proforma. Both proformas are then stress tested at an average of four different recessionary levels. The proformas are stress tested at different vacancy rates. When analyzing the proformas, the underwriter will take the time to analyze the different income sources and expenses. The underwriter will analyze the following expenses: repairs and maintenance, utilities, administrative, insurance, taxes, trash, management, and other miscellaneous fees.

What does this show a lender?

This will show the lender how a property will perform in the best and worst conditions; how sensitive the property is to an economic downturn and if the property will produce enough income at different recessionary levels to meet debt obligations. When analyzing the proformas, the underwriter will make sure that the borrower’s income is at market if not greater and that the expenses are at market if not less. This analysis will show the lender the net operating income, net cash flow, capitalization rate, and the debt yield.

Other items

The lender will also analyze the draw schedule, monthly cash flow, proforma for the last three years, rent roll, master budget, and the allocated loan amount per unit.
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