In the world of multifamily property underwriting, one crucial factor that investors and lenders must consider is the impact of interest rates on underwriting. This consideration becomes especially important during periods of rising interest rates. In such times, it is essential to determine whether to use trended rents or untrended rents when assessing the property’s potential income. In this article, we will explore the differences between these two methods and the implications of using each method in a rising interest rate environment.

Trended Rents

Trended rents are a method of estimating potential rental income that accounts for historical rent increases. This method assumes that rents will continue to increase at the same rate as they have in the past. For example, if a property has experienced an average annual rent increase of 3% over the last five years, trended rents would assume that rents will increase by 3% per year going forward. This method is often used by lenders and investors who want to project future income with greater accuracy.

Untrended Rents

Untrended rents, on the other hand, are a more conservative approach to estimating potential rental income. This method assumes that rents will remain the same as they are at the time of underwriting. This method is often used by lenders and investors who want to be more cautious in their projections and to account for the possibility of stagnant rental growth.

Implications of Using Trended Rents vs. Untrended Rents in a Rising Interest Rate Environment

In a period of rising interest rates, using trended rents can be advantageous as it provides a more accurate projection of future income. This is because rising inflation will lead to higher costs for property owners, including higher mortgage payments, and higher rents. By using trended rents, lenders and investors can assess whether the property’s income can cover these increased costs.

However, there is a risk to using trended rents in a rising interest rate environment. If rental growth slows down due to decreased demand, the projection based on trended rents could prove to be overly optimistic, resulting in lower-than-expected income. This could put the property’s financial performance in jeopardy, potentially leading to default or foreclosure.

On the other hand, using untrended rents in a rising interest rate environment can provide a more conservative estimate of future income, which could be beneficial in mitigating risk. However, it could also lead to missed opportunities as underwriting will show higher costs and higher interest rates, but not the associated higher rents. As a result, deals will be passed up as they don’t provide adequate rates of return.

Conclusion

In conclusion, when underwriting a multifamily property in a period of rising interest rates, the choice between trended rents and untrended rents should be carefully considered. Trended rents provide a more accurate projection of future income, but they come with the risk of overestimating income if rental growth slows down. Untrended rents provide a more conservative estimate of future income, but they could result in missed opportunities. Ultimately, the choice between these two methods should be based on the specific circumstances of the property and the level of risk that the lender or investor is comfortable with.