A typical real estate transaction has so many moving parts that it’s easy to get caught up in the minutiae. With market fluctuations, technological advances, and changes to the home buying industry, today’s investors must pay close attention to ensure that nothing falls through the cracks. One aspect of the real estate transaction underwriting process exists specifically to assist investors (and lenders) in avoiding potentially risky deals. Before you approach your next deal, read the following guide to learn how to make the most of commercial underwriting in real estate.
What Is Underwriting In Real Estate?
The process of reviewing a loan application to determine the amount of risk involved in real estate underwriting. To assess the deal’s potential, the underwriter will consider the borrower’s financial situation as well as the value of the property at hand. Underwriting is an important part of the transaction process because it allows both investors and lenders to avoid failing properties.
Simply put, real estate underwriting is comparable to the loan pre-approval process. Both examine a borrower’s financial situation to determine the viability of a transaction. The distinction is that underwriting takes into account the level of risk involved and, in many cases, requires additional information from the borrower. Because lenders do not always require this extensive process, many investors will learn how to underwrite a deal on their own (with the guidance of a financial advisor).
How Does Commercial Real Estate Underwriting Work?
When a loan application is submitted, or when an investor decides to complete the underwriting for potential investment deals, the real estate underwriting process can begin in one of two ways. Underwriting is used to assess an applicant’s financial integrity and typically covers four areas: income, credit, asset information, and home appraisal.
In terms of income, the underwriter will decide whether your earnings are sufficient to cover your mortgage payments. Expect to be asked to provide proof of your monthly income, such as your most recent W-2s, pay stubs, and bank statements. They’ll also assess your creditworthiness. A high credit score shows the lender that you are more likely to repay your debts and allows you to qualify for a lower interest rate. Although lenders require different credit scores depending on the type of loan, the minimum score is between 580 and 620.
Another important indicator that they will consider is the debt-to-income ratio.
Your assets can also help you get a mortgage. The underwriter will assess the value of your assets, which can be sold for cash if you fall behind on your mortgage payments. Personal assets include checking and savings accounts, real estate, stocks, and personal property. Finally, a property appraisal is almost always required. By conducting a property appraisal, you and your lender will have the peace of mind that you will only borrow enough money to cover the home’s actual value. This procedure also aids in keeping the seller honest.
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A typical underwriting process can last anywhere from a few days to a week. The most time-consuming part will be ensuring that all necessary paperwork is submitted on time. Any borrower hoping to expedite the process should prepare the necessary documentation ahead of time and be responsive to any communications from their lender. The decision and review of any approval conditions are the final steps in the process.
Investors looking to evaluate investment opportunities can also complete the real estate underwriting process. This entails going over the property numbers with a careful deal analyzer. Consider net operating income, return on investment, and other factors. Investors who choose to underwrite their transactions will have them reviewed by a third party (typically a broker or financial advisor). Following that, investors will anticipate potential scenarios and plan possible reactions and outcomes. To be clear, self-underwriting real estate is not a way to get a loan. Instead, it is another tool for assessing risk in a potential transaction.
Variables Influencing the Underwriting Procedure
Individual investors looking to make commercial real estate investment deals should test and challenge five critical assumptions as part of the underwriting process:
Rent and projected growth have a direct impact on all other metrics used to assess the financial performance of an income-producing property. Inexperienced real estate investors may “plug in” a fixed percentage rent growth amount, but this can lead to a poor investment decision.
Vacancy in rental property can occur in two ways. Then there’s the time it takes to find a new tenant after the old one moves out. Second, vacancy can be caused by eviction and the time required to repair the property before it can be rented again. Some types of properties may have higher vacancy rates than others.
Cash flow forecast
Investors and underwriters can create more reliable cash flow forecasts by accurately predicting rent growth and vacancy rates. Gross rental income or cash flow is the total amount of revenue generated by the property, whereas net cash flow or net operating income is the amount of money left over after paying operating expenses and servicing debt.
Potential return on investment
Investment return can be measured in a variety of ways, including gross yield, cash-on-cash, and IRR (or an annualized rate of return). The entry and exit cap rates, on the other hand, are one of the most basic measures of return.
The entry – or “going in” – rate is simple to calculate by dividing the actual net operating income by the property’s current market value: NOI / Market value = cap rate
The exit cap rate, or “going out” cap rate when the property is sold, is much more difficult to predict. This is because accurate forecasts of rental income, operating expenses, property market value, and cap rates for similar properties must be made several years in advance.
Underwriting Real Estate Acquisitions
Underwriting is the research and analysis of an asset that predicts its potential risk, likely returns, the price it should be purchased for, and the price at which an investor can exit the investment in a future sale in commercial real estate acquisitions.
To calculate the likely cash flow for a given property, underwriting considers several factors. To make this prediction, numerous components must be evaluated.
What Role Does Underwriting Play in Real Estate Investing?
The entire underwriting process is intended to validate assumptions made by the acquisition team during the initial asset screening and to determine whether the investment thesis presented is deliverable. Rising focuses on locating assets that will benefit from post-acquisition capital expenditures to add value to the property. This strategy is aptly named ‘value-add,’ but there are four different strategic approaches a sponsor will consider when looking at any specific asset, and which to use for any given property will be determined by the institutional investor partner’s requirements.
To be clear, there are numerous ways for sponsors to develop their investment strategy. For example, we may work with a single institutional investor on a specific asset and, in some cases, a group of institutions or family offices on a single transaction. Each will have a unique investment strategy, and our approach and recommendations will be tailored accordingly.
The first step in underwriting any acquisition is determining whether a single asset can deliver the investment thesis we seek. Once this is determined, the detailed underwriting process can begin.
Real Estate Underwriting Certification
To become a real estate underwriter, you will almost certainly need to complete a bachelor’s degree program. Internships and focused coursework provide additional training. Learn about what you’d study as a student and get information on real estate underwriting certification options. Examine the job prospects in this field.
What Education Do I Require to Work as a Real Estate Underwriter?
Most companies, according to the U.S. Bureau of Labor Statistics (BLS), require prospective underwriters to have a bachelor’s degree in a field such as accounting or finance. A four-year degree program can help you understand the business protocol, account management, financial forecasting, and the factors that can affect a company’s bottom line. Business finance, portfolio management, macroeconomics, capital management, accounting, and risk measurement are examples of courses that may be offered. According to the BLS, experience in the field is highly valued by insurance companies (www.bls.gov).
What Kinds of Training Are Available?
Internships, on-the-job training, and formal courses can all be used to obtain real estate underwriter training. These programs allow you to choose a field in which to specialize. You learn how to use risk analysis software, calculate risk-based premiums, contact the appropriate people for policy explanations, and navigate insurance databases. There are also additional courses available for beginning underwriters through organizations such as the Insurance Institute of America.
What About Certification?
A few organizations offer voluntary certification, with options tailored to your chosen specialization. You can, for example, obtain certification in commercial, private, real estate, life, or health underwriting. These can help you advance in your career or increase your salary; the qualifications required vary depending on your level of experience and education.
Underwriting in real estate assists lenders and investors in avoiding putting capital into a property that is likely to become a problem. No investor enjoys being denied a loan or being asked to make a larger down payment, accept a higher interest rate, and accept more restrictive loan terms.
Understanding how real estate underwriting works allows investors to think like a lender and make better decisions when purchasing a rental property.
Frequently Asked Questions
What does underwriting mean for mortgage?
After you submit your application, mortgage underwriting takes place behind the scenes. It is the process by which a lender examines your credit and financial history to determine if you are eligible for a loan.
How long does it take for the underwriter to make a decision?
Mortgage underwriting can take a day or two, or it can take weeks, depending on these factors. In most cases, initial underwriting approval occurs within 72 hours of submitting your full loan file. In extreme cases, this process could take up to a month.
Can an underwriter deny a loan?
An underwriter may deny a loan simply because they lack sufficient information to approve it. A well-written letter of explanation may help the underwriter understand a large cash deposit in your account, explain a debt that was paid by someone else or clarify gaps in employment.
What is an example of underwriting?
A health insurance underwriter, for example, will look at medical information, whereas a loan underwriter will look at things like credit history. The job of an underwriter is difficult. Based on their risk assessment, they must determine an acceptable level of risk and what is eligible for approval.