A phrase everyone uses, and most don't define
Every syndicator says their underwriting is conservative. It's become a word people reach for without saying what it costs them. I'd rather tell you what it actually means at Cardinal Oak, including the deals it forces us to walk away from.
It starts with the worst case, not the average case
Most underwriting models start with a reasonable rent growth assumption and work forward from there. Ours starts with worst-case rent growth instead. If the deal still works when rents grow slower than we expect, and sometimes don't grow at all for a stretch, that's a deal worth looking at further. If it only works when everything goes right, it's not a deal, it's a hope.
We do the same thing with the exit. We stress-test the cap rate we'd need to sell at, assuming it's worse than today's, not better. Cap rates move with interest rates and the broader market, and none of us control either one. Assuming the market does us a favor on the way out is how good-looking spreadsheets turn into bad outcomes.
Occupancy assumptions matter more than people think
We underwrite conservative occupancy from day one, not the occupancy the seller's broker put in the marketing package. A property showing 95% occupancy today might run at 90% under new management while leases turn over, maintenance catches up, and tenants adjust to a different way of doing things. If the numbers only pencil at 95%, we don't buy it.
What this looks like in practice
We evaluate hundreds of deals to close two or three a year. That ratio isn't an accident, it's the result of running every deal through this process and watching most of them fail it. The willingness to walk away is the discipline, not a side effect of it.
A few things we check before a deal advances:
- Rent growth assumptions tested against a flat or declining scenario, not just the trend line
- Exit cap rate assumed higher than today's market, not equal to it
- Occupancy modeled conservatively through the renovation and lease-up period
- A credible, specific plan to force appreciation through the property itself, not a bet that the market rises around it
If a property needs best-case assumptions to hit its numbers, we pass. That's happened more than once with buildings we liked on paper. Liking a building isn't the same as trusting the math behind it.
Why this matters to an investor evaluating a sponsor
Anyone can build a model that shows a strong return. The real question is what the model assumes to get there. Ask a sponsor what happens to their projected return if rent growth is zero for two years, or if the exit cap rate is a point higher than today's. If they don't have a ready answer, that tells you something about how the deal was underwritten in the first place.
We report monthly, including what went wrong, not just what went right. Conservative underwriting and honest reporting are the same habit applied at different points in the deal. One happens before we buy. The other happens every month after.
Returns are projections, not promises, and the assumptions behind them are something we're glad to walk through.
Talk it through
If you want to see how this plays out on a specific property, schedule a call with John or read our full thesis.