Everything you need to evaluate a deal — cap rate, DSCR, IRR, cash-on-cash, equity multiple, and the 70% rule — with formulas, worked examples, and the benchmarks that matter.
15-minute read · Updated May 2025
Real estate underwriting is the process of analyzing a property's financial performance to determine whether it makes sense to buy, at what price, and at what terms. Done well, underwriting tells you not just whether a deal "pencils" today, but how resilient it is to changes in rent growth, interest rates, vacancy, and exit conditions.
Professional underwriters build models that answer three questions:
The goal is never false precision — it's disciplined estimation. A 5.8% cap rate computed carefully beats a 6.2% cap rate computed carelessly.
The cap rate is the most widely used metric in commercial real estate. It expresses the relationship between a property's net operating income and its price, independent of financing.
Worked example: A 12-unit apartment building generates $312,000 in gross rent annually. After 5% vacancy ($15,600) and $108,000 in operating expenses (taxes, insurance, maintenance, management), the NOI is $188,400. If the asking price is $3,100,000:
What it means: A 6.08% cap rate means the property yields 6.08 cents for every dollar of value if bought free and clear. Higher cap rates generally mean higher yield — but often for a reason (worse location, older asset, higher vacancy risk).
Benchmarks (2025):
When to use it: Cap rate is most useful for comparing properties of the same type in the same market. Never compare a Phoenix suburban multifamily cap rate to a Manhattan industrial cap rate — the benchmarks are completely different.
The DSCR tells you how much cushion exists between the property's income and its debt obligations. It's the primary metric lenders use to qualify a loan.
Worked example: Using the same 12-unit building above (NOI: $188,400). The buyer takes a $2,325,000 loan (75% LTV) at 7.0% over 30 years. Annual debt service (P&I) = $185,904.
At 1.01x, this deal barely covers debt service — most lenders require 1.20–1.30x. The buyer would need to either lower the price, put more equity in, or find a lower rate.
Benchmarks:
Cash-on-cash (CoC) measures the annual pre-tax cash flow as a percentage of the equity invested. Unlike cap rate, it's financing-dependent — the same property looks very different at different LTV ratios or interest rates.
Worked example: With the 12-unit building, NOI is $188,400 and annual debt service is $185,904. Year-1 cash flow = $188,400 − $185,904 = $2,496. Equity invested (25% down + 2% closing costs) = $837,500.
A 0.3% cash-on-cash is essentially zero — this deal requires rates to drop or rents to grow materially before it makes sense at this price.
Benchmarks: Most institutional investors target 5–8% cash-on-cash in a neutral rate environment. At 7%+ interest rates, 3–5% cash-on-cash is more realistic on quality assets.
IRR is the discount rate that makes the net present value (NPV) of all cash flows equal to zero — effectively the annualized return on invested capital over the full hold period including the exit. It's the most comprehensive single metric for evaluating a real estate investment.
Worked example: An investor buys a property for $3,100,000 (equity: $837,500). It generates modest Year-1 cash flow, rents grow at 3%/yr, and the property is sold in Year 5 at a 6.0% exit cap. The projected IRR over the 5-year hold is 11.2%.
Benchmarks:
The IRR trap: IRR is highly sensitive to the assumed exit cap rate. A deal modeled at a 5.5% exit cap that trades at 6.5% will drastically underperform projections. Always run a sensitivity grid on exit cap rate.
The equity multiple tells you the total return on invested capital in absolute terms. An equity multiple of 2.0x means every dollar invested returned two dollars (including the original).
Worked example: An investor puts in $837,500, receives $42,000 in cumulative cash flows over 5 years, and collects $1,200,000 at exit (after repaying the loan). Total return = $1,242,000.
The equity multiple is most useful when compared alongside IRR — a 1.5x multiple in 3 years (25% IRR) is very different from a 1.5x multiple in 10 years (4% IRR). Use both together.
Benchmarks: Value-add deals targeting 15% IRR over 5 years should produce roughly 2.0x equity multiple. Core deals targeting 9% IRR over 7 years might produce 1.8x.
The 70% rule is a quick filter used in residential investing, particularly fix-and-flip. It sets a maximum acquisition price based on the after-repair value (ARV) and estimated rehab cost.
Worked example: A property has an ARV of $420,000 and needs $55,000 in rehab.
If the asking price is $265,000, the deal fails the 70% rule — the investor is likely overpaying relative to their profit margin target. The 30% spread is designed to cover holding costs, financing costs, agent fees (typically 6%), and still leave a 10–15% profit margin.
When to bend it: In highly competitive markets or on properties with very high ARVs, experienced investors sometimes use 75–80% instead. The key is keeping your effective margin consistent — the 70% number is a heuristic, not a law.
| Metric | Best for | Blind spot |
|---|---|---|
| Cap rate | Comparing assets, quick pricing sanity check | Ignores financing completely |
| DSCR | Lender qualification, debt safety margin | Says nothing about equity returns |
| Cash-on-cash | Year 1 income check, passive income investing | Ignores appreciation and equity paydown |
| IRR | Full-hold return including exit, LP presentations | Highly sensitive to exit cap assumptions |
| Equity multiple | Absolute return sanity check alongside IRR | Ignores time value of money |
| 70% rule | Fast residential flip screening | Too blunt for complex or high-ARV deals |
No single metric tells the full story. A disciplined underwriter looks at all of them together, stress-tests the assumptions that matter most, and walks away from deals that don't work on multiple dimensions — not just the one number that looks best.
REDealIQ computes every metric on this page — live, as you type. Cap rate, DSCR, IRR, cash-on-cash, equity multiple, and the 70% rule. No spreadsheet required.
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