Are You Buying a Deal or Buying a Problem? A Multifamily Underwriting Guide

Every real estate deal looks good until it does not.

The brochure is polished, the photos are appealing, the broker has a convincing story, and the projected returns seem to support everything you want to believe. Then the property closes, the first month passes, the expenses begin to appear, and suddenly the deal does not look anything like it did on paper.

The truth is that most deals tell you what they are before you buy them. The problem is that many investors do not know how to listen.

I have been investing in small multifamily properties for years, and I have seen smart, successful people lose money in real estate. Doctors, engineers, business owners, and experienced investors can all make the same mistake. They become optimistic in places where a professional investor needs to be conservative.

Optimism feels good when you are trying to make a deal work. It feels positive and productive. You begin telling yourself that rents will rise faster, expenses will fall sooner, vacancies will remain low, and repairs will not be as bad as they appear.

Then cash flow disappears.

Distributions shrink, reserves begin to drain, and the confidence that attracted everyone to the deal is replaced by stress.

Numbers do not care how badly you want the property. They do not care how much time you have already spent underwriting it or how exciting it would be to tell people you closed another deal.

Numbers simply tell the truth.

Effective multifamily underwriting is not designed to help you fall in love with a property. It is designed to help you uncover the truth before the property becomes your responsibility.

The difference between buying a great investment and buying a problem often comes down to three areas that investors underestimate:

• Vacancy
• Capital improvements
• Management costs

These three numbers can change everything.

The Deal That Did Not Feel Right

There have been times when I looked at a deal and something inside me felt uneasy, even though the numbers appeared acceptable.

That feeling matters.

Early in my investing journey, I was looking at a property in Oklahoma. On the surface, the deal looked like it could work. There were reasons to move forward, and it would have been easy to convince myself that the concerns were manageable.

But the more I looked, the more uncomfortable I became.

I could have ignored that feeling because I wanted the deal. I could have adjusted assumptions until the numbers supported the decision I had already made emotionally.

Instead, I pulled out.

Walking away from a deal can feel like failure when you have spent time, money, and energy trying to close it. In reality, walking away may be one of the strongest decisions an investor makes.

The goal is not to buy every property you analyze. The goal is to buy the right property at the right price with enough protection built into the plan.

This is why real estate deal analysis must be objective. You are not looking for numbers that justify your excitement. You are looking for evidence that the property can support the proposed debt, expenses, renovations, and investor expectations.

Vacancy Is More Than an Empty Apartment

Vacancy is one of the fastest ways to destroy cash flow in a small multifamily property.

Many investors look at national occupancy reports and assume that if the market is averaging around 95 percent occupancy, their property will do the same. Those national numbers often include stabilized properties with large management teams, strong marketing systems, and hundreds of units over which to spread the risk.

Small, older properties in secondary markets may experience much higher true vacancy once you consider turnover, make ready time, uncollected rent, and units that are technically occupied but not producing income.

The math looks very different depending on property size:

• In a 100 unit property, one vacant apartment represents 1 percent vacancy.
• In a 12 unit property, one vacant apartment represents more than 8 percent.
• Lose two tenants in that 12 unit property and you have lost nearly 17 percent of your potential rental income.

Example: Imagine a 12 unit property with rents of $1,000 per month.

• Potential monthly collection: $12,000
• If two units become vacant: $2,000/month lost, or $24,000/year
• If the property was producing $60,000 in net operating income, those two vacancies could reduce that income by 40 percent

That is why one door matters so much in small multifamily. You do not have 200 apartments to absorb the loss. Every vacancy changes the math.

We have our property managers track how much money is being lost every day a unit remains vacant. I want them to see the financial cost of an apartment sitting empty, because vacancy is not only a leasing problem. It is an income problem.

When underwriting smaller Class C properties, I often use a 10 percent vacancy assumption. For a property going through renovations or a management transition, I may use 15 percent until the property becomes stable.

I would rather underwrite conservatively and overdeliver to investors than build the business plan on perfect conditions that may never exist.

Vacancy Can Reveal a Management Problem

Not all vacancies are caused by the market. Sometimes it comes down to:

• Rent priced too high for the area
• Poor photos or inconsistent marketing
• No positive reviews online
• A make ready process that takes three weeks when it should take seven days
• Renewals not handled until the last minute
• Management not responding to leads quickly enough

At one of our properties, Serenity Ridge, we were told there were three vacant units. When we arrived, we discovered there were actually ten.

That was not a small difference.

The property went from what appeared to be around 10 percent vacancy to more than 30 percent vacancy. That kind of surprise can change the entire first year of ownership.

You must verify what you are being told.

Do not rely only on the offering memorandum, seller’s rent roll, or broker’s summary. Confirm occupancy, collections, lease status, delinquency, and unit condition during your due diligence.

During a takeover, vacancy may also increase because residents are nervous about the new ownership. Some assume rents will rise and leave before they receive a notice. Others may be involved in behavior that the previous management ignored.

At one property, we discovered that a maintenance worker was buying stolen tires from people and running his own black market business out of the maintenance room.

We installed cameras.

That is not the kind of situation you usually find described in the offering memorandum, but it is part of operating real estate.

When you take over a property, you may be changing more than management. You may be changing the entire culture of the community.

Capital Improvements Are Not Decoration

The second major problem is underestimating capital improvements — one of the most common underwriting mistakes I see.

Investors often confuse renovations with capital expenditures. They focus on flooring, paint, cabinets, appliances, and fixtures because those are the improvements residents see.

Capital expenditures are the systems that keep the property functioning:

• Roofs
• Plumbing lines
• Electrical panels
• HVAC systems
• Foundations
• Windows
• Drainage
• Parking lots
• Sewer lines
• Structural repairs

These may not make a property look beautiful, but they can destroy the investment when they fail.

A broker may describe a property as needing light renovations and suggest that turns will cost $1,500 per unit. That number may cover paint and inexpensive flooring, but it will not protect you from aging systems or deferred maintenance.

For many properties built in the 1970s and 1980s, I may begin with a capital budget of $6,000 to $8,000 per unit before considering larger renovations. That number can rise quickly depending on the condition of the property.

A strong multifamily underwriting process separates cosmetic renovations from major capital needs. Combining them into one vague renovation number can create a dangerous gap in your budget.

During due diligence, walk the property with contractors and experienced property managers and check:

• Age and condition of the roof
• Number of HVAC systems and their service records
• Electrical panels and plumbing materials
• Drainage, foundations, windows, and wood rot
• Parking areas, lighting, and laundry rooms
• Unit interiors

Do not assume that because a system is working today, it will continue working for the next five years.

Underfunding Capital Can Reduce Property Value

Underfunding capital improvements hurts the deal in several ways.

Example: Imagine buying a 20 unit property that truly needs $5,000 per unit in improvements.

• Actual need: $100,000
• Budgeted: $40,000
• Shortfall: $60,000

When the repairs become necessary, that money has to come from somewhere. You may use operating income, delay distributions, request more money from investors, or take on additional debt.

If repairs pull $15,000 per year from the property’s net operating income, the effect is much larger than the immediate expense.

The repair did not only cost you $15,000. It affected cash flow, refinancing potential, investor returns, and the eventual sale price.

Net operating income affects almost everything in multifamily investing. When you use operating money to pay for repairs that should have been included in the original capital budget, your returns decline and the property becomes harder to refinance or sell.

A strong capital budget is not an unnecessary expense. It is protection.

Management Costs More on Small Properties

The third number investors often underestimate is property management.

Smaller properties usually cost more per unit to manage because the property manager is spreading staff, software, travel, maintenance, and administrative costs over fewer apartments.

A large apartment community may support an onsite manager and maintenance team dedicated to one property. Smaller properties often share those resources with several other communities — meaning the property may not receive immediate attention every time there is a problem.

• Large properties: management fees of 3 to 5 percent
• Smaller properties (fewer than 20 units): more realistically 8 to 12 percent

Some investors underwrite a 5 percent management fee because that is the number they saw in a course or on a larger property. On an eight unit property, that may be fantasy.

Self management is not free either. It is another job. You may not write yourself a check each month, but your time, stress, travel, phone calls, tenant issues, leasing, and maintenance coordination all have value.

The Management Fee Is Only the Beginning

The monthly percentage is not the full cost of property management. Many contracts include:

• Leasing fees
• Renewal fees
• Maintenance markups
• Eviction charges
• Court filing costs
• Software fees
• Inspection fees
• Administrative expenses

At one property in Oklahoma, our management company charged us for printing, postage, and even company birthday parties. When we questioned the charges, they pointed to a broad section of the contract that allowed them to pass certain expenses back to the owners.

Those charges may appear small individually, but they add up. A property with an 8 percent management fee may have a true management cost closer to 12 or 14 percent after all additional charges are included.

That does not mean property management is a bad expense. A good property manager can protect your net operating income by reducing vacancy, improving collections, handling renewals, controlling repairs, and identifying capital issues before they become emergencies.

The goal is not to pay as little as possible. The goal is to receive value for what you pay.

When I underwrite a small property, I may use a 10 percent management assumption even if the company quotes 8 percent. I also include leasing costs, renewal expenses, maintenance markups, and software fees.

If the actual cost is lower, the property performs better than expected — a much better conversation to have with investors than explaining why distributions disappeared.

The Slow Bleed of a Bad Deal

Bad deals do not always fail dramatically.

Sometimes they bleed slowly:

• Vacancy rises by one unit, then another
• Repairs begin to consume operating income
• The property manager adds charges that were not included in the original projections
• Distributions shrink
• Communication becomes less frequent
• The ownership team begins reacting to problems instead of managing them

I met an investor who put $150,000 into a deal. Everything seemed fine until it was not.

The general partners stopped communicating. The financial performance surprised them, and once the property began losing money, they did not know how to stop it.

The deal became reactive instead of proactive.

The property eventually moved toward foreclosure, and the investor lost every dollar.

Her loss was not only financial. She lost trust in the people running the property and confidence in real estate investing.

That is why communication, conservative underwriting, and experienced guidance matter.

Investors should never be surprised by problems that could have been identified, planned for, or communicated earlier.

A spreadsheet alone cannot protect a deal. Investors also need a realistic business plan, operating oversight, adequate reserves, and a team that communicates when conditions change.

Buy the Problem You Know How to Solve

The best opportunities in real estate are often properties with problems. Vacancy, poor management, deferred maintenance, and below market rents can all create value.

The question is not whether the property has problems. The question is whether you understand them, have enough money to solve them, and have the right people to execute the plan.

• A poorly managed property may become a great investment when the vacancy is caused by weak leasing systems.
• An older property may have strong potential when the capital needs are accurately priced into the purchase.
• A property with high expenses may become valuable when the costs can be reduced without hurting operations.

But a problem only becomes an opportunity when it is understood. Otherwise, you are simply buying someone else’s trouble.

The goal of small multifamily investing is not to find a property with no problems. The goal is to identify problems you can accurately price, properly fund, and realistically solve.

Listen to What the Deal Is Telling You

Before purchasing your next small multifamily property, look carefully at vacancy, capital improvements, and management.

Do not use the best case scenario. Stress the numbers.

Ask what happens if:

• Two units become vacant
• Repairs cost twice as much as expected
• Management fees are higher than the initial quote

Call several property managers in the area. Walk every major system. Review historical occupancy, collections, and actual expenses.

Most importantly, do not adjust the numbers simply because you want the deal. Numbers do not lie.

I built my portfolio by starting small and being willing to learn. My first 16 unit property was considered too small by many people, but it became one of our strongest cash flowing assets.

The numbers on that deal:

• Purchase price: $560,000
• Capital raised: $250,000
• Set aside for capital improvements: ~$120,000
• Average rents at purchase: ~$497 → grown to ~$950
• Refinanced after 20 months, pulled out $170,000
• Now produces average distributable income of more than $6,000/month

That property created wealth because we did more than buy it. We operated it, improved it, and stayed involved in the business plan.

Not every property will become a deal like that. Some should never be purchased.

Your job as an investor is not to force every property to work. Your job is to know the difference between an opportunity and a warning.

Whether you are researching how to buy your first multifamily property or preparing to expand an existing portfolio, the same principle applies: protect yourself on the front end by telling the truth about the numbers.

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Frequently Asked Questions

What vacancy rate should I use when underwriting a small multifamily property?

For smaller Class C properties, a 10 percent vacancy assumption is a conservative starting point. If the property is going through renovations or a management transition, consider using 15 percent until it becomes stable.

Why do small multifamily properties have higher effective vacancy than national averages?

National occupancy reports often reflect large, stabilized properties with strong management and marketing systems spread across hundreds of units. A small, older property in a secondary market does not have that same cushion, so a single vacant unit has a much bigger impact on total income.

What is the difference between renovations and capital expenditures?

Renovations are the improvements residents see, such as flooring, paint, cabinets, and fixtures. Capital expenditures are the systems that keep the property functioning, such as roofs, plumbing, electrical panels, HVAC, foundations, and drainage. Underestimating capital needs by lumping them into a vague renovation budget is one of the most common underwriting mistakes.

How much should I budget for capital improvements on an older property?

For properties built in the 1970s and 1980s, a starting capital budget of $6,000 to $8,000 per unit is a reasonable baseline before accounting for larger renovation needs, and this figure can rise depending on the property’s condition.

What property management fee should I underwrite for a small multifamily property?

Large properties may pay management fees of 3 to 5 percent, but smaller properties, especially those with fewer than 20 units, more realistically cost 8 to 12 percent once leasing fees, renewal fees, maintenance markups, and administrative charges are factored in.

Is self-managing a small multifamily property actually free?

No. Self-management is not free, it is another job. Time, stress, travel, phone calls, tenant issues, leasing, and maintenance coordination all carry real value, even if you are not writing yourself a monthly check.