Fort Features: Underwriting
If you have ever been around or had any connection to Commercial Real Estate, you have probably heard the term “Underwriting”. Fort Capital is constantly in the process of underwriting and underwrites hundreds of deals each year. Some of the deals never see the light of day and others that are successful can be viewed on our Portfolio page. Whether you are new to the industry or a seasoned professional, we have outlined our underwriting process from start to finish below and hope that it helps in your future endeavors.
What is “Underwriting”?
Definition: The process of identifying the degree of risk for each entity before assuming that risk.
Our Perspective: Valuing a piece of real estate.
What variables contribute to the value?
Each asset is different and has its own unique set of variables, but some of the standard variables are:
- Purchase Price
- Expenses
- Expense Growth
- Cap Ex Requirements
- Taxes/Insurance (or the estimated)
- Tenants (number and lease duration)
- Rent (compared to the market value)
- Tenant Renewable Probability
- Current Vacancies
- Lease-Up Timing
- Tenant Improvement Cost
- Refinance Scenario
- Exit Cap
- Market Demographics & Trends
- Market Predictability (What the market will do in 5 years? What do we anticipate as the selling cost?)
Is underwriting the first step in the process?
Yes, this is how we start evaluating if a piece of real estate is worth purchasing. At the beginning of the process, you don’t have a lot of facts—you have a lot of assumptions. As you move forward in the process, you try to remove unknown variables and assumptions.
How long does the process typically take?
It depends on the ‘institutional knowledge’ readily available on the asset/market and your familiarity with the craft of underwriting. It can be as fast as a week or several months depending on the complexity and responsiveness. However, getting to a quick no is important. Too much time can be spent underwriting deals that a professional would have seen as a “no” out of the gate.
Where do you get the information? What are the sources of data?
This is where it helps to have trusted partners. Many times, we work with the specific asset brokers who have access to proprietary databases as well as lease comps of similar properties. Learn more about our Partner Incentive Program here.
Speaking of properties, we currently own 26 properties in DFW, so we gather data from our portfolio and how our assets are performing.
Last, we hire a team of experts, for our internal Acquisitions and Investments teams, with a wide breadth of knowledge and encourage those members to share their expertise at every step in the process.
Where does this information live? How does it get communicated to the team and externally?
1. We utilize our internal operating system, FOS, to keep all documents and models in one place. This system allows team members to tailor the content and processes for their individual needs.
2. We generate checklists so nothing gets missed, and the process remains consistent and thorough.
3. We structure folders on our server so that all documents stay organized and easy for all necessary team members to access.
4. For each property under consideration, we begin populating data into our “base model.” As we eliminate assumptions and expand our knowledge this model expands and adapts to each specific property.
What is the final product? What are the next steps after underwriting?
Like we said in the introduction, this is a constant process and many deals don’t see the light of day. However, when we have eliminated enough assumptions and feel confident that an asset will provide benefit to our Portfolio and our Investors, we submit an offer and go under contract.
What are the important or key details that people typically miss? What are mistakes that you have made?
1. Not paying enough attention to CapEx terms and assumptions. Examples include the age and condition of the HVAC, roof, parking lot, and land specification.
2. Not analyzing details and clauses within existing tenant leases.
3. Not leaning on your team for expertise. This includes lenders, banks, brokers, team members, and your own Portfolio.
4. Not creating or being honest with a realistic downside case. We create this case for every asset, and while it stays internal, it is often a critical element in the final decision of going under contract.
Any final thoughts on underwriting?
1. Remember you are evaluating risk, so it is important to be honest with the information you are given. This will create greater certainty and ultimately eliminate variables.
2. Consider adding a risk-adjusted return (similar to a realistic downside case). This helps you predict the ‘bad times’ like economic fluctuations.
3. Don’t forget the importance of relationships with Capital Partners and Lenders. Once these partners begin trusting your underwriting and get familiar with your process, you will start to reap benefits.
4. Be open to new opportunities and think outside the box. Especially in these uncertain times where we are experiencing a lag in data, if you wait for opportunities to fall into the pipeline or wait for things to return to “normal,” you will likely miss several great opportunities.
5. We encourage thoughtful disagreements. We like to play devil’s advocate, so we are prepared for any scenario—even the bad ones. The downfall of decision making is when everyone in the room says “yes”.