How to Underwrite a Small Multifamily Deal (Under 20 Units): A CRE Walkthrough

Five units is the line where residential math stops working. Below it, the lender underwrites your buyer's W-2. At five units and up, the lender underwrites the building. To underwrite a small multifamily deal, you have to read it like an operator, not a borrower.

Most residential agents stall right there. The deal is not bigger. It is scored differently. Anything under 20 units is the friendliest place to learn, because the numbers stay small enough to hold in your head and the sellers are often individuals rather than funds.

Here is the framework I coach agents through when they bring me their first 8 or 12 unit deal.

Start with the rent roll, not the asking price

The asking price is the seller's opinion. The rent roll is the fact pattern. Pull it first.

A rent roll lists every unit, the tenant, the lease dates, and the rent actually collected. Read it for three things:

• Units below market. That is upside, if the leases roll over soon.
• Units above market. That is risk, because the rent may not renew at that level.
• Vacancies and month-to-month tenants. Both change your income assumption.

If reading one still feels slow, fix that before you write an offer. How to read a rent roll (with real examples) walks the format line by line.

Build the income number the property actually earns

Start with gross potential rent. That is the total if every unit paid market rent for twelve months. Rent is the base, but it is not the whole income. Small buildings often carry a few other lines: coin laundry, reserved parking, storage, or utility reimbursement billed back to tenants. Count them only if the current leases actually collect them.

Then take two subtractions.

First, vacancy and credit loss. Some units sit empty and some tenants pay late or not at all. A submarket vacancy figure gives you a working number to hold back.

What remains is effective gross income. That is the money the building really collects in a normal year.

Turn income into NOI

Now subtract operating expenses: taxes, insurance, utilities, management, repairs, and a reserve for the roof and mechanicals you will replace later. Do not subtract the mortgage. Debt is not an operating expense, and mixing it in is the single most common rookie error.

Effective gross income minus operating expenses is net operating income, or NOI. NOI is the number the whole deal turns on. Understanding NOI covers why one wrong line here moves the value by six figures.

A screening shortcut: on small multifamily, operating expenses often land somewhere near 40 to 50 percent of effective gross income. Treat that as a smell test, not a fact. If the seller hands you a number far below it, they are probably leaving out management, reserves, or a real tax bill. Always rebuild NOI from the property's actual trailing-twelve statement before you trust it.

Run the two returns that matter

With NOI in hand, two numbers tell you if the deal is any good.

Cap rate is NOI divided by price. It is the unleveraged yield, the return if you paid all cash. It lets you compare this building to the last three you looked at on the same footing.

Cash-on-cash is annual pre-tax cash flow divided by the cash you actually put in. It is the number your investor client feels in their bank account. A simple cash-on-cash framework breaks the calculation down step by step.

Pressure-test the debt before you celebrate

A healthy cap rate can still be a dead deal once the loan is on it. This is where most first-timers get surprised.

Lenders size the loan on debt service coverage ratio, or DSCR: NOI divided by annual debt service. If NOI is 84,000 and the loan payment is 82,000, DSCR is about 1.02. Most small multifamily lenders want more cushion than that before they fund. When the deal does not cover, you have two levers: negotiate the price down, or put more cash in to shrink the loan.

A worked example: a 12 unit deal

Say a 12 unit building is listed at 1,350,000. Twelve units at 1,100 a month is 158,400 in gross potential rent. Hold 5 percent back for vacancy and you have about 150,000 in effective gross income. Operating expenses of roughly 66,000 leave NOI near 84,000.

At the 1,350,000 asking price, that is about a 6.2 percent cap rate. On its own, it looks fine.

Now add the loan. At 75 percent leverage, the debt is a little over a million, and at current small-balance rates the annual payment lands close to 82,000. DSCR is about 1.02. The building barely covers its own mortgage, and the cash flow is a rounding error.

That is the lesson. The cap rate said go. The debt said stop. To make this deal work, the buyer needs the price closer to 1.2 million, or a larger down payment to bring DSCR into a range a lender will actually fund. Every figure here is illustrative, meant to show the method, not to quote a market.

A quick underwriting checklist

Before you take a small multifamily deal seriously, confirm you have:

• The actual rent roll and the trailing-twelve operating statement, not a pro forma.
• NOI you rebuilt yourself, with management and reserves included.
• Cap rate at the asking price, and the price where the cap rate makes sense to you.
• A DSCR run at a realistic loan, so you know the deal finances before you write it.

The three numbers to bring the seller

When you call the listing agent, lead with what you can defend: your NOI, the cap rate that NOI implies at their price, and the DSCR a normal loan produces. You are not lowballing. You are showing your work. Sellers argue with opinions and respect math.

That is the whole job of underwriting a small multifamily deal. Not to predict the future, but to know which of the seller's numbers survive contact with a lender.

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Khai Tran, Licensed Real Estate Agent in Texas. Brokered By eXp Realty.