Stress-Testing Your Underwriting: Survive the “What-Ifs” Before They Happen

Why Stress Testing?

Great underwriting isn’t about the best-case—it’s about survivability. Stress tests reveal whether your deal holds up when vacancy rises, expenses inflate, or rates move. They protect you from overpaying today and getting trapped at refinance or sale.

Build Your Base Case (Then Try To Break It)

1. Start with reality: Trailing-12 income/expenses, current rent roll, actual collections.

2. Normalize: Remove one-offs, align taxes/insurance/utilities with market.

3. Document assumptions: Rent growth, expense growth, CapEx timing, exit cap—all stated, sourced, and reasonable.

4. Now stress it. Your model should include toggles for:

   • Vacancy/Concessions: +200–500 bps

   • Rent Growth: 0% for 12–24 months

   • Expense Inflation: +5–10% (insurance and taxes often need higher)

   • Interest Rate Shock (floating): +150–300 bps; include SOFR floors

   • Refi Risk: Higher exit cap (+50–150 bps), lower LTV, tighter DSCR

   • CapEx Overrun: +10–20% and delays

Stress Scenarios to Run

• Mild: Vacancy +2%, expenses +3%, exit cap +50 bps

• Moderate: Vacancy +4%, expenses +6%, rates +150 bps, exit cap +75 bps

• Severe: Vacancy +6–8%, expenses +10–12%, rates +300 bps, exit cap +100–150 bps, refi proceeds capped

Track outputs: DSCR, DY, Cash-on-Cash, Equity Multiple, Breakeven Occupancy, Refi Proceeds.

Refinance Stress Test (the silent killer)

• Refi DSCR requirement (e.g., 1.25×) at stressed rate.

• Max LTV and DY gates reduce proceeds.

• Exit cap expansion compresses value → less refi cash, possible equity gap.

• Solution: Extend hold, add reserves, or reduce leverage on day one.

Insurance & Taxes: Build a Separate Stress

• Insurance: rebid annually; model +15–25% shock, then 5–10% trend.

• Taxes: underwrite post-sale reassessment; model worst-case based on jurisdiction.

Go/No-Go Rules (examples)

• Min DSCR under Moderate Stress: ≥ 1.10×

• Cash Flow Cushion: Property remains cash-flow positive under Mild stress by Year 2

• Refi Coverage: Under Moderate stress, refi proceeds ≥ existing balance without equity injection

• Equity Multiple: ≥ 1.8× at base case; ≥ 1.5× under Moderate

Reporting Pack For IC/Partners

• 1-page Assumptions Summary

• Scenario Table (Base/Mild/Moderate/Severe) with KPIs

• Waterfall Sensitivity: equity returns vs. rent growth and exit cap

• Mitigations: reserves, rate caps, staged CapEx, vendor savings

Practical Mitigations

• Rate Cap with escrow; model the cap cost

• Staggered lease expirations to tame turnover spikes

• OPEX controls via vendor playbook (see Blog #4)

• Contingency reserves (3–6 months of operating + debt service)

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