Most beginner underwriting goes wrong in the same place. Not in the math, which is straightforward, but in the inputs. Someone takes the seller’s rent figure, subtracts the seller’s expense figure, divides by the asking price, and concludes the deal works.
It usually does not. Seller pro formas are marketing documents. They show what a building could earn in a perfect year with no vacancy, no turnover cost, and expenses that quietly exclude management, reserves, and half the real repair budget.
Analyzing a multifamily deal properly means rebuilding those numbers from verifiable sources, then running them through metrics that tell you different things. Here is how to do it on an LA building, with a worked example.
Start With the Income Side
Income flows down through three stages. Each one removes optimism.
Gross Potential Income (GPI)
What the building would earn at 100% occupancy with every unit at your underwritten rent, plus other income.
Build it from the rent roll, not from a marketing flyer. You want unit numbers, tenant names, move-in dates, lease terms, current rents, and deposits held. Then add other income: laundry, parking, storage, pet rent, and any utility reimbursement.
The critical judgment here is which rent you use. Sellers often present market rent. Use actual in-place rent as your base case. The gap between the two is loss-to-lease, and it is upside, not income.
Effective Gross Income (EGI)
GPI minus vacancy and credit loss.
Underwriting 0% vacancy is the fastest way to build a fragile model. LA metro vacancy sat at roughly 4.5% to 5.5% in 2026 depending on the data source, and individual buildings swing above that during turnover. A 5% assumption is defensible for a stabilized LA building. Value-add plans with heavy turnover should model more.
Credit loss, meaning tenants who simply do not pay, belongs here too. In rent-controlled stock with long eviction timelines, that is not a theoretical line item.
Operating Expenses
This is where most first-time analyses fall apart, because the seller’s expense schedule is frequently incomplete.
Expenses to include, every time:
- Property taxes, reassessed at your purchase price, not the seller’s basis. In California this is the single most commonly understated expense. Proposition 13 means the seller may be paying tax on a decades-old assessment while you will pay on today’s price.
- Insurance, which has risen sharply across California
- Property management, typically 4% to 8%, even if you plan to self-manage. Your time has a cost, and a buyer or lender will underwrite it regardless.
- Repairs and maintenance
- Utilities the owner pays
- Trash, pest, landscaping, and other contracted services
- Capital reserves, commonly $250 to $400 per unit per year
- LAHD registration fees and SCEP inspection costs for RSO properties
A reasonable expense ratio for an older LA building typically lands between 35% and 45% of EGI. If a seller’s statement shows 25%, something is missing.
Net Operating Income (NOI)
NOI = EGI minus operating expenses
NOI excludes debt service, depreciation, and capital expenditures. That is deliberate: NOI describes the property’s performance independent of how you finance it, which is what makes cross-property comparison possible.
Cap Rate: What It Tells You and When It Lies
Cap Rate = NOI / Purchase Price
Flip it to value a building: Value = NOI / Cap Rate
A 5% cap rate means the property yields 5% on an all-cash basis in year one.
LA Cap Rate Ranges in 2026
Metro-wide averages have run roughly 5.4% to 5.8% in 2026 depending on the data source, with meaningful submarket spread:
| Submarket Type | Typical Cap Range |
|---|---|
| Prime Westside (Santa Monica, Beverly Hills) | 3.5% to 4.5% |
| Mid-city (Koreatown, Hollywood, Silver Lake) | 4% to 5% |
| South LA, Valley, emerging submarkets | 5% to 6%+ |
Cap rates have expanded for six consecutive quarters, which means comparisons against 2021 or 2022 pricing will mislead you.
Where Cap Rate Misleads
It ignores financing entirely. Two buyers purchasing the same building at the same cap rate can have completely different cash returns depending on their debt.
It is a single-year snapshot. A building at a 5% going-in cap with substantial loss-to-lease may reach 6.5% stabilized. One at 5% with rents already at market stays at 5%.
It is only as good as the NOI. A cap rate computed on a seller’s inflated NOI is a fiction. Recompute it on your own numbers before you compare anything.
Going-in versus exit cap matters for projections. Assuming you will sell at a lower cap rate than you bought at is an assumption, not a plan, and in a rising-rate environment it is an optimistic one.
Cash-on-Cash Return: What You Actually Earn
Cap rate measures the asset. Cash-on-cash measures your position in it.
Cash-on-Cash = Annual Pre-Tax Cash Flow / Total Cash Invested
Where annual cash flow is NOI minus annual debt service, and total cash invested includes down payment, closing costs, and any upfront capital work.
This is the number that tells you what your money is doing. It moves with leverage, and not always in the direction people expect.
Positive leverage occurs when your cap rate exceeds your loan constant. Borrowing amplifies returns.
Negative leverage occurs when your borrowing cost exceeds the asset’s yield. Adding debt then reduces your cash flow. With LA cap rates running in the 4% to 6% range against borrowing costs near or above 5.5%, negative leverage is a live condition in this market, not a hypothetical.
Debt Service Coverage Ratio: The Constraint That Decides Your Loan
DSCR = NOI / Annual Debt Service
Commercial lenders typically require 1.20 to 1.25 for stabilized multifamily.
This matters more than most buyers expect, because DSCR, not your equity, determines your loan size. A building with suppressed RSO rents produces suppressed NOI, and suppressed NOI supports a smaller loan no matter what the property is worth.
Working backward from a required DSCR tells you the maximum debt service the property supports, and therefore the maximum loan. Do that calculation before you assume a purchase price is financeable.
Worked Example: A 10-Unit Building in South LA
Assume a 10-unit RSO building, asking $2,400,000.
Income
| Line | Amount |
|---|---|
| 10 units averaging $1,650/month | $198,000 |
| Other income (laundry, parking) | $6,000 |
| Gross Potential Income | $204,000 |
| Less vacancy and credit loss at 5% | ($10,200) |
| Effective Gross Income | $193,800 |
Expenses
| Line | Amount |
|---|---|
| Property taxes (reassessed at ~1.25% of price) | $30,000 |
| Insurance | $14,000 |
| Property management at 6% of EGI | $11,628 |
| Repairs and maintenance | $15,000 |
| Utilities (owner-paid water, trash) | $12,000 |
| Landscaping, pest, contracted services | $4,500 |
| Capital reserves at $300/unit | $3,000 |
| LAHD fees and compliance | $1,500 |
| Total Operating Expenses | $91,628 |
Expense ratio: 47% of EGI, on the high side, driven by the tax reassessment and owner-paid utilities.
Results
- NOI = $193,800 minus $91,628 = $102,172
- Cap rate at asking = $102,172 / $2,400,000 = 4.26%
- Value at a 5% market cap = $102,172 / 0.05 = $2,043,440
At a 5% market cap, this building is worth roughly $2.04 million, not $2.4 million. The asking price implies a 4.26% cap, which is Westside pricing for a South LA asset.
Financing check
Assume 30% down ($720,000) and a $1,680,000 loan at 6.0% on 30-year amortization, roughly $120,900 annual debt service.
- DSCR = $102,172 / $120,900 = 0.85
That fails. Most lenders need 1.20 to 1.25. Working backward from 1.25, maximum supportable debt service is about $81,700, implying a loan closer to $1.13 million and a far larger equity requirement.
Cash-on-cash, if the deal were financed as assumed, would be negative: $102,172 minus $120,900 equals negative $18,728 before capital expenditures.
This is exactly the analysis that stops a bad purchase. The building is not unbuyable, but not at that price with that debt structure.
The Upside Case: Loss-to-Lease
The example above uses in-place rents. Suppose market rent in that submarket is $2,100 rather than $1,650.
The gap is $450 per unit per month, $54,000 per year of income the building is not capturing. That is loss-to-lease, and it is the reason value-add buyers pay attention to buildings like this.
Under the Costa-Hawkins Act, vacancy decontrol lets you reset an RSO unit to market when a tenant voluntarily leaves. So the gap is recoverable, over time, through turnover.
Two cautions that separate realistic underwriting from wishful thinking:
Turnover timing drives everything. Long-tenured tenants in rent-stabilized units do not move quickly. Model a realistic annual turnover rate and a recovery timeline of years, not months.
Rent increases will not close the gap. As of July 1, 2026, the LA RSO cap was permanently reduced to 4% annually, down from a prior ceiling of 8%. You cannot raise your way to market on an occupied unit. Turnover is the mechanism. Our guide on the current law on rent increases in LA covers the specifics.
Red Flags in Seller Financials
Things that should slow you down:
- Pro forma rents presented as current income. Ask for the certified rent roll and the trailing 12-month statement.
- Property taxes shown at the seller’s basis. Reassessment at your purchase price is often the largest single expense change.
- No management fee. It belongs in the model whether or not you self-manage.
- No capital reserves. Roofs and water heaters are not optional.
- Expense ratio below 30% on an older building. Something is excluded.
- Rent history that does not match LAHD records. Pull the RSO rent history independently.
- “Market rent” comps with no source. Ask which specific properties, at what unit mix, leased when.
- Unexplained vacancy. Units held empty before a sale can indicate a problem, or a seller attempting to show decontrol upside.
- Soft-story status not disclosed. With the April 2026 Priority 2 deadline passed, this is a live liability.
Your Underwriting Checklist
Before you offer:
- Certified rent roll with move-in dates and deposits
- Trailing 12-month operating statement
- Two to three years of operating history
- All leases and addenda
- 12+ months of utility bills
- LAHD rent registration and independently pulled rent history
- Certificate of occupancy confirming build date and RSO status
- Soft-story retrofit status
- Verified market rent comps
- Reassessed property tax estimate at your purchase price
- Lender pre-quote with realistic DSCR sizing
- Capital expenditure walk with a contractor
Common Mistakes
Using pro forma as the base case. Underwrite actual, treat upside separately.
Forgetting the tax reassessment. California’s Proposition 13 means the seller’s tax bill is not yours.
Omitting management. Even self-managed buildings carry the cost.
Assuming zero vacancy. LA metro vacancy has run roughly 4.5% to 5.5% in 2026.
Ignoring DSCR until financing. It determines your loan, and it binds before your equity does.
Comparing cap rates across submarkets. A 5% cap in Santa Monica and a 5% cap in the Valley describe different risks.
Treating loss-to-lease as immediate. It arrives through turnover, and the 4% RSO cap means it cannot be raised into.
Expert Tips
- Recompute every number the seller gives you. The rent roll is a starting point, not a conclusion.
- Run three cases: in-place, realistic stabilized, and downside with higher vacancy and one major capital item.
- Sensitivity-test the cap rate. If exit cap moves 50 basis points against you, does the deal still work?
- Get the lender quote early, before the LOI, so you know what the building can actually borrow.
- Verify RSO status at ZIMAS before you underwrite rent growth at all.
For the broader acquisition process this analysis sits inside, see our guide on buying a multifamily property in Los Angeles. If you are on the other side of the transaction, our guide on valuing your apartment building before selling covers the same math from the seller’s perspective.
Frequently Asked Questions
How do I calculate NOI? Start with gross potential income, which is all units at their in-place rent plus other income. Subtract vacancy and credit loss to get effective gross income. Subtract all operating expenses including reassessed property taxes, insurance, management, maintenance, utilities, and reserves. What remains is net operating income. NOI excludes debt service and capital expenditures.
What is a good cap rate for LA multifamily? It depends on submarket and strategy. Metro-wide 2026 averages have run roughly 5.4% to 5.8%, with prime Westside product at 3.5% to 4.5%, mid-city at 4% to 5%, and South LA, the Valley, and emerging submarkets at 5% to 6% or higher.
What is the difference between cap rate and cash-on-cash? Cap rate measures the property’s unleveraged yield, NOI divided by price, and lets you compare buildings regardless of financing. Cash-on-cash measures your return on the cash you actually invested after debt service, so it changes with your loan terms.
Why do sellers’ pro formas lie? They are marketing documents. They typically show market rents rather than in-place rents, assume little or no vacancy, use the seller’s pre-reassessment property tax figure, and omit management fees and capital reserves. None of that is necessarily deceptive, but none of it is your operating reality either.
How do I verify a rent roll? Request the certified rent roll with move-in dates, cross-check it against the trailing 12-month statement, review the actual leases, obtain tenant estoppel certificates confirming rent and deposits, and for RSO properties pull the rent history independently from the LA Housing Department rather than accepting the seller’s version.
What vacancy rate should I underwrite? Around 5% is defensible for a stabilized LA building, given metro vacancy running roughly 4.5% to 5.5% in 2026. Value-add plans involving significant turnover should model higher, and you should include credit loss separately.
What expenses do beginners forget? Property tax reassessment at the purchase price, property management when self-managing, capital reserves, LAHD registration and SCEP compliance costs for RSO buildings, and the true cost of turnover including make-ready work and lost rent.
How do I value a building from its NOI? Divide NOI by the market cap rate for comparable properties in that submarket. A building producing $102,000 in NOI valued at a 5% market cap is worth roughly $2.04 million. Cross-check that figure against price per unit and recent comparable sales.
What is DSCR and what do lenders require? Debt service coverage ratio is NOI divided by annual debt service. Commercial multifamily lenders typically require 1.20 to 1.25 for stabilized properties. Because DSCR sizes your loan, a building with suppressed rents may support far less debt than its value suggests.
How does loss-to-lease create upside in LA? Loss-to-lease is the gap between in-place and market rents. Under Costa-Hawkins vacancy decontrol, an RSO unit can be reset to market when a tenant voluntarily vacates, so the gap is recoverable through turnover. It is not recoverable through rent increases, since the RSO cap is 4% annually as of July 1, 2026.
What is a good cash-on-cash return? It depends on your cost of capital and risk tolerance, but in the current LA market many buyers target mid-single digits on stabilized assets, accepting lower initial returns for value-add deals where stabilized cash flow is projected higher. Negative cash-on-cash in year one is common on heavy value-add and should be a deliberate choice, not a surprise.
Run the Numbers Before You Fall in Love
Underwriting is what separates investing from speculating. The math is not difficult. The discipline is in refusing to accept someone else’s inputs, in pricing the tax reassessment honestly, and in checking what the building can actually borrow before deciding what it is worth to you.
If you are evaluating a specific building in Los Angeles or the South Bay and want a second set of eyes on the numbers, reach out. A free analysis costs you nothing and occasionally saves a great deal.
