Why I Passed on a “6.5% Cap” Multifamily Deal That Was Really a 4.9%

A broker package crossed my desk on a value-add multifamily deal — a Class B/C garden complex in a Southeastern secondary market. The pro forma showed a 6.5% stabilized cap rate and a clean "just push rents to market" value-add story. On the cover, it was a buy.

I underwrote it and got to a real going-in cap closer to 4.9%, a debt service coverage ratio that wouldn't clear the lender once the loan amortized, and an internal rate of return that only worked if I assumed I'd sell at a lower cap rate than I bought at. I passed.

The gap between that 6.5% and my 4.9% is the whole story — and every haircut in between is one most buyers skip. Here it is, line by line.

(This is a composite drawn from deals of this type, not a single identifiable property.)

The broker pro forma is a marketing document

Start here, because it's the mistake underneath every other mistake: a seller's pro forma is not an underwrite. It's the deal at its best imaginable state — full market rents, stabilized occupancy, trimmed expenses, no friction, no vacancy during the work, no cost to get there. It isn't a lie, exactly. It's a brochure. The seller is showing you the destination and pricing you for having already arrived.

Your job is the opposite: underwrite the in-place reality first, then decide, line by line, how much of the projected upside you actually believe and what it costs to capture. The broker cap rate — purchase price over the pro forma NOI — answers a question you don't care about. You care about the true cap rate: the yield on NOI rebuilt from real economics. Here's how the brochure number came apart.

Haircut 1 — "market rents" aren't free, or instant

The value-add thesis was the usual one: push rents to market, capture the spread. Maybe the spread is real. But the pro forma booked the full rent increase as if it appeared on day one at zero cost. It doesn't. Getting there means renovation dollars per unit, units offline while you turn them, slower lease-up, and concessions to fill the repositioned product. Real underwriting phases the increase in over 18 to 30 months, nets the renovation capital against it, and discounts the units that never quite hit the projected rent. By the time you account for the friction, a meaningful chunk of the headline "upside" is gone — and what's left is back-weighted, which matters enormously for IRR.

Haircut 2 — reserves are real money, not an accounting nicety

The broker cap was computed on NOI before replacement reserves. Roofs, HVAC, parking lots, unit turns — that capital isn't optional, it's just deferred, and pretending it doesn't exist inflates the yield you actually keep. I run cap rate on a reserves-aware basis: pre-reserves NOI sets the headline valuation, but the cash flow that actually reaches me — and therefore the returns — is post-reserves. On this deal, a realistic per-unit reserve was enough on its own to move the cap rate by a noticeable fraction of a point. Skip it and you're capitalizing income you'll spend anyway.

Haircut 3 — vacancy spikes before it settles

The pro forma used 5% economic vacancy — a stabilized-state number. But this was a deal you have to destabilize to improve. During a reposition you push existing tenants out to renovate, occupancy dips, and you carry concession and loss-to-lease drag while you fill at the new rents. The real economic vacancy through the value-add period — physical vacancy plus bad debt plus concessions — runs well above the stabilized figure. Underwriting the calm after the storm while pricing in none of the storm is how repositions blow their year-one and year-two numbers.

Haircut 4 — DSCR at P&I, and the negative-leverage trap

The pro forma leaned on an interest-only period to flatter early cash flow. Fine for a teaser, dangerous as a basis for a decision. The loan amortizes eventually, and DSCR at principal-and-interest — not the IO honeymoon — is the test that decides whether you survive year four. This deal's P&I coverage came in under the lender's minimum.

Worse, at a real going-in cap of 4.9% against debt costing north of 6%, you're in negative leverage from day one: borrowing makes your levered return worse than the all-cash yield until rent growth closes the gap. Negative leverage isn't automatically fatal — but you'd better be very sure about the rent growth that's supposed to rescue it, and the broker's rent growth was the same optimistic number from Haircut 1.

Haircut 5 — the exit cap, where fake IRRs are manufactured

This is the big one. The single largest lever on a too-good IRR is the exit cap rate, and seller pro formas love to set the exit cap at or below the entry cap. That quietly manufactures appreciation out of thin air — you "make money" simply by assuming the next buyer pays a richer multiple than you did.

I underwrite the opposite: a modest exit cap expansion over a five-to-ten-year hold. Rates move, buildings age, and you should not bank a sale on the market handing you a better cap than you could negotiate going in. When I put an honest, slightly-expanded exit cap on this deal, the IRR fell apart — because most of the projected return wasn't coming from operations at all. It was an assumed multiple expansion I had no business underwriting as fact.

Stacking the haircuts

None of these individually killed the deal. Stacked, they were decisive. The brochure: 6.5% stabilized cap, IO-flattered coverage, IRR in the high teens. The real underwrite: roughly a 4.9% going-in cap, DSCR below the lender's P&I floor, negative leverage at entry, and an IRR that collapsed under an honest exit assumption. Same building, same rent roll, same financing — two completely different deals, depending on whether you underwrite the brochure or the property.

The decision — and why "pass" is a position, not a failure

A 4.9% deal isn't automatically bad. At the right basis, for the right hold, with rent growth you genuinely believe, sub-5% can pencil. But it has to be priced as a 4.9%, not a 6.5%. The way you make a deal like this work is the oldest one there is: pay less. My number was well below ask. The seller, predictably, had a buyer willing to take the pro forma at face value. Let them. The discipline that protects you isn't finding reasons to do deals — it's refusing to inherit the seller's optimism at the seller's price.

The takeaway

Never underwrite the seller's pro forma. Underwrite the in-place reality and haircut the upside to what you actually believe you can execute. Reserves are real, vacancy spikes before it settles, DSCR at P&I is the test that matters, and the exit cap should expand, not compress. The gap between the broker cap and the true cap is the entire negotiation — and it's where the deal is won or lost before you ever sign.

Run the same checks yourself: the multifamily pro forma calculator to build NOI from the rent roll up, the cap rate calculator to see the broker cap and the true cap side by side, and the DSCR calculator for the debt test at P&I. If you want the full picture — a complete 10-year model with reserves, P&I coverage, a defensible exit cap, and a deal score — that's what UpsideIQ runs. (New to the metrics? Start with the multifamily underwriting guide.)

Written by Michael Laudino, founder of LFO Capital LLC, who underwrites multifamily and industrial acquisitions across the Southeast. UpsideIQ is LFO Capital's institutional-grade underwriting platform. This article is for informational purposes only and is not investment advice.