The Importance of Sound Underwriting in Real Estate Investing

In this article:

• What is Underwriting in Real Estate?

• Underwriting in Commercial Real Estate

• What Does a Real Estate Underwriter Do? (Underwriting Best Practices)

• Underwriting Challenges

• The Commercial Real Estate Underwriting Process

• Underwriting in Real Estate Crowdfunding

• What Does a Real Estate Underwriter Do at The Stream Group?

• Conclusion

• FAQs — Real Estate Underwriting

What is Underwriting in Real Estate?

Real estate underwriting is the process of assessing the risk and potential returns of a real estate investment opportunity. It involves a comprehensive evaluation of the investment's viability, focusing on projected risk-adjusted returns. In commercial real estate, underwriting includes a detailed analysis of both the property and the borrower (the sponsor or operator), ensuring the investment aligns with the investor’s financial goals and risk tolerance.

Underwriting in Commercial Real Estate

In commercial real estate, underwriting is crucial for evaluating the soundness of an investment. This involves a thorough scrutiny of the property's location, market trends, property condition, and potential income. For lenders, it ensures that the borrower can service and repay the loan. For investors, especially those on crowdfunding platforms, it assures that the property, operator, and business plan have been thoroughly assessed.

What Does a Real Estate Underwriter Do? (Underwriting Best Practices)

Best practices in real estate underwriting include:

• Due Diligence: Conduct a thorough investigation of the property, including location, market trends, property condition, and potential rental income. Ensure no disputes on the property title and assess risks like natural disasters.

• Sponsor Check: Examine the borrower’s financial status, including credit history, current debts, and overall financial health.

• Detailed Financial Analysis: Scrutinize the pro forma and other quantitative elements of the business plan, using metrics like the debt-service coverage ratio (DSCR) to determine if the property can generate enough income to cover loan payments.

• Property Valuation: Order and review property appraisals to ensure the property’s value aligns with the loan amount requested.

• Legal Scrutiny: Ensure the borrower and property have no legal disputes, with clear titles and compliance with zoning laws.

• Risk Assessment: Identify potential risks related to the property’s location or market volatility.

Underwriting Challenges

Underwriters face several challenges, including:

• Incomplete Borrower Information: Applicants sometimes submit partial or outdated financial records.

• Overvalued Appraisals: In hot markets, appraisals may inflate property values.

• Changing Market Conditions: Economic shifts can impact borrower qualifications and property values.

Skilled underwriters navigate these challenges using their expertise and sound judgment, balancing risk mitigation with business goals.

The Commercial Real Estate Underwriting Process

The underwriting process in commercial real estate involves several phases:

1. Underwriting by the Sponsor, Developer, or Operator: Assessing if the property and thesis fit their strategy and capital parameters.

2. Underwriting by Lenders: Evaluating total leverage and loan services versus collateral and the financial health of the borrower.

3. Underwriting by LP Investors: Conducting due diligence on the sponsor and the investment.

Underwriting in Real Estate Crowdfunding

Real estate crowdfunding has opened up commercial real estate opportunities to individual accredited investors. Platforms like The Stream Group offer a steady flow of opportunities, making thorough underwriting essential.

For individual investors, important underwriting steps include:

• Platform Vetting: Ensuring the platform conducts rigorous scrutiny of investment opportunities.

• Transparency: Access to detailed information about the property, projected returns, and associated risks.

• Diversification: Spreading investments across multiple ventures.

• Alignment with Investor Goals: Ensuring the properties listed align with the overall investment goals of the platform’s user base.

What Does a Real Estate Underwriter Do at The Stream Group?

The Stream Group’s underwriting process includes:

1. Initial Screening: Assessing the sponsor and project at a high level using proprietary scoring frameworks.

2. Sponsor Due Diligence: Evaluating the sponsor’s track record, creditworthiness, and background.

3. Stress Testing and Scenario Modeling: Examining the sponsor’s underwriting and conducting independent modeling of cash flows and potential returns.

4. Identification of Risk Factors: Documenting potential risks to the business plan.

5. Investment Committee Review and Voting: Each investment must pass a final vote by the Investment Committee.

Only around 5% of potential investments pass The Stream Group's underwriting process and are featured on the platform.

Conclusion

Sound underwriting is the backbone of a strong real estate portfolio. It ensures that only the most promising investments are presented to investors, mitigating risks and maximizing potential returns. Accredited investors should understand the underwriting process and perform their own due diligence on each investing platform they consider.

FAQs — Real Estate Underwriting

Q: What is real estate underwriting?
A: Real estate underwriting is the process of assessing the risk and potential returns of a real estate investment opportunity.

Q: Why is underwriting important in real estate investing?
A: Underwriting is crucial for evaluating the viability of an investment, ensuring it aligns with the investor’s financial goals and risk tolerance.

Q: What are the key components of real estate underwriting?
A: Key components include due diligence, sponsor check, detailed financial analysis, property valuation, legal scrutiny, and risk assessment.

Q: What challenges do underwriters face?
A: Challenges include incomplete borrower information, overvalued appraisals, and changing market conditions.

Q: How does The Stream Group ensure quality underwriting?
A: The Stream Group employs a thorough underwriting process that includes initial screening, sponsor due diligence, stress testing, risk identification, and a final review by the Investment Committee.

Q: What role does underwriting play in real estate crowdfunding?
A: Underwriting in crowdfunding ensures that only the most promising investments are presented to investors, providing transparency and alignment with investor goals.

For more information, visit The Stream Group or contact our Investor Relations Team.

About the Author

Timothy Shaw

Timothy Shaw is a Founding Partner at The Stream Group. Leveraging his broad experience in real estate, he provides strategic guidance and advisory support. His background includes multifamily syndications, distressed asset acquisition, and serving as a licensed real estate salesperson in Ohio. At The Stream Group, Tim focuses on ownership and investment strategies, ensuring the firm’s long-term growth and vision.

Before his real estate career, Tim served as a lieutenant in the fire department. His career in public safety allowed him the opportunity to serve in many roles, including firefighter, flight paramedic, hazardous materials technician, and certified fire safety inspector. This background instilled a deep commitment to service and integrity, values he brings to his work with investors, tenants, and team members.

A graduate of the University of Cincinnati with a degree in Fire Science Engineering, Tim is dedicated to creating an environment where systems and data drive success. He admires Warren Buffett’s investment philosophy: “When others are greedy be scared, when others are scared be greedy.”

Tim is married with two children and enjoys traveling with his wife. They spend their free time at their second home on Amelia Island.