How to Stop Underwriting Crappy Deals and Focus on the Gold
It starts long before you ever see an OM
Since I started buying real estate 15 years ago, I've looked at thousands of potential deals.
And bought roughly 40.
That's a lot of wheat to separate from the chaff.
So over the years, I've developed ways to spend less time on deals that won't go anywhere on more time on the ones that have real potential.
If I have a superpower in this business, that's it: Spotting great deals without having to underwrite a hundred to get there.
So when I was asked on a podcast the other day, "What do you look at first when you open an OM?" It forced me to think about how I actually do what I do.
And what I came up with on the fly wasn't bad:
"It starts long before you ever see an OM."
First: Define, then redefine your box.
Then narrow it even further.
The tighter your criteria, the easier it is to filter deals that don't fit, and to know what to look for when you find one that does.
Don't say: Multifamily west of the Rockies
Say: '1990s and 2000s vintage multifamily, 100-300 units, tertiary markets, light value add with a 200bps Return on Cost spread to debt cost within 36 months.
Or more specifically to San Francisco:
Don't say: Multifamily 10 units and up
Say: Multifamily 10-15 units, no resident manager, no elevator, few long-term tenants, light value add and no structural upgrades required
This doesn't just help better manage inbound deal flow, but helps brokers who are out there hunting down deals for you. They'll send you fewer deals that don't meet your criteria, making better use of both their time and yours.
Second: Define your metrics (and keep it simple).
Once you've defined your box, define your metrics.
Choose 2-3 key metrics that will tell you in three minutes whether the deal moves to the top of the pile or the bottom.
In my rent controlled market, I use:
Price per foot
GRM (gross rent multiplier) and,
Tenancy weighted loss-to-lease (meaning how much upside are there in leases that were signed in the past few years)
No one metric should have the power do kick out a deal on its own, but if all three point in the same direction it's worth listening to.
For example, if I skim through an OM and notice a deal that's asking $500 per foot, with a GRM of 12, a rent roll where half tenants who moved in when Reagan was president, it's an immediate pass.
No reason to spend time on it.
Does that mean I'd never buy the property? Of course not, there's (almost) always a price. But the listing is clearly overpriced and either someone will overpay, or within a couple months the broker and/or seller will come down to earth.
At which point it may warrant a closer look.
Third: Filter, prioritize, focus
I hear and read about people complaining about "underwriting all these crappy deals," and I wonder, why are you underwriting crappy deals?
If you've done the first two steps, those crappy deals are at the bottom of your list and shouldn't see the light of a spreadsheet unless they've sat on the market for months.
So now that the chaff is out of the way, you can dig into the good stuff.
Deals with potential are worth the vast majority of your time and attention, both behind the desk and out in the field. Tour the property, bring through your contractors, study the comps, study the market, develop the business plan, tweak the model, sharpen your pencil.
But: You only have enough time to do this right if you’ve already set aside the deals that don't fit.
If you try to dig into every deal that kinda-maybe-sorta-almost fits, you'll do a mediocre job of evaluating, which will lead to doing mediocre deals.
A fair question is whether this process means you'll miss some deals, ones that didn't pass your initial screen but you should have looked at anyway.
Sure, it can happen.
In my experience though it usually doesn't, and in the long run you'll give yourself a much better of chance of doing more and better deals.
And if you're goal is anything other than that, you're wasting your and your capital's time.