How We Stress-Test Every Deal
Underwriting is the process of analyzing whether a property will make money. It's the single most important skill in real estate investing. Bad underwriting leads to bad deals. Here's how we evaluate every property at Fairmeadow Capital.
The Five Numbers That Matter
Every deal comes down to five core metrics. If these don't work, the deal doesn't work, regardless of how good the property looks.
Net Operating Income (NOI)
Gross rental income minus operating expenses (taxes, insurance, maintenance, management, vacancy). Does not include debt service.
NOI = Gross Rent - Vacancy - Operating ExpensesCap Rate
Annual NOI as a percentage of purchase price. Measures the unlevered return. In Cleveland, we target 8-12% cap rates on small multifamily.
Cap Rate = NOI / Purchase PriceCash-on-Cash Return
Annual cash flow (after debt service) divided by total cash invested. This is your actual return on the dollars you put in. We target 8-12%.
CoC = Annual Cash Flow / Total Cash InvestedDSCR
Debt Service Coverage Ratio. How many times the property's NOI covers the debt payment. Lenders require 1.20x+. We won't buy below 1.25x.
DSCR = NOI / Annual Debt ServiceGross Rent Multiplier (GRM)
Purchase price divided by annual gross rent. A quick screening tool. In Cleveland, we look for GRMs under 6-7x on small multifamily, meaning the property costs less than 7 years of gross rent.
GRM = Purchase Price / Annual Gross RentHow We Stress-Test
The numbers above only matter if they hold up under pressure. We underwrite every deal with conservative assumptions:
Even in a strong rental market. Accounts for turnover, eviction, and make-ready time.
Older buildings need more. We budget higher for pre-1960 construction.
Roof, HVAC, water heater, plumbing. These are coming whether you budget for them or not.
Even if self-managing today. The property should support professional management.
We underwrite at a higher rate than quoted. If rates rise before close, the deal still works.
Red Flags in Underwriting
- ✗ Seller's pro forma uses 3-5% vacancy in a market that averages 8%+
- ✗ No budget for CapEx on a building with a 20-year-old roof
- ✗ Rents are "projected" at above-market rates with no renovation plan
- ✗ The deal only works with optimistic appreciation assumptions
- ✗ Operating expenses are suspiciously low (often missing management or reserves)
Try it yourself
Use our calculators to practice underwriting with real numbers.