# Build Order Guide > Illustrative teaching case. Northgate Commons is not a real property, this is not a real transaction, and the term sheet is not a real financing quote. Every figure is fabricated for instruction. Underwriting has an order. Working out of order is a common reason a model takes twice as long and still does not tie. Six steps, in this sequence. --- ## Step 1. Tie the rent roll to the operating statement Before you use either document, prove they describe the same property. The rent roll is dated 2026-12-31, which is the last month of the operating statement. Three figures should match that month exactly: - Gross potential rent should equal the sum of market rents on all 120 units. - Loss to lease should equal the sum of (market rent less current rent) across occupied units. Watch the sign on the month-to-month units. - Vacancy loss should equal the market rent on the vacant units. If they tie, you can trust the pair. If they had not tied, that is the first diligence question, not something to model around. While you are in the rent roll, note what is there: units on month-to-month, long-tenured residents renewed well below market, vacant units in different stages of turn. Loss to lease is not one number spread evenly. It is concentrated, and where it is concentrated tells you how fast it can be captured. ## Step 2. Normalize the trailing twelve months This is the whole exercise. The seller's statement is a record of how the seller ran the property. You are buying it with a loan on it and a manager in place. Work down the expense lines and ask one question of each: **would this line look the same next year under new ownership?** Three of them will not. - One expense in the statement is not an operating expense at all. It is capital that was charged to an operating line. Read the statement notes and look at the monthly pattern in repairs and maintenance; a genuine operating expense rarely appears once and never again. - One expense that a buyer is likely to pay, and that the lender will impose regardless, does not appear anywhere in the statement. Ask what the seller does that a buyer would pay someone else to do. The market rate is in the submarket survey. - One expense is real but is going to change on closing for a reason that has nothing to do with how you operate. The offering memorandum tells you the rule. Apply it at the price you are underwriting. Two of those three cut net operating income and one raises it, so a partial catch lands you somewhere plausible and wrong. Then add the replacement reserve from the assumptions file. **Your output from this step is a single number.** Everything downstream inherits it, so it is worth being certain before you move on. ## Step 3. Size the loan The term sheet gives three tests and says proceeds are the lesser of the three. Run all three. Students who have seen a few deals tend to run loan to value and coverage, because those are the two that usually bind, and skip the third. - **Loan to value:** the maximum percentage applied to the purchase price. - **Coverage:** net operating income divided by the minimum coverage ratio, divided by the annual constant. Use the fully amortizing constant, not the interest-only payment, because the term sheet says so. The constant is printed on the term sheet if you would rather not derive it. - **Debt yield:** net operating income divided by the minimum debt yield. No rate, no amortization, no price. Take the lowest. Round down to a round figure the way a lender would. Then note which test bound, because that is the sentence the investment committee will ask about. ## Step 4. Project five years Grow effective gross income and operating expenses at the rates in the assumptions file. Two details: - The management fee is a percentage of that year's effective gross income, so it grows with revenue rather than at the expense growth rate. - Project a sixth year as well. You need it for the exit, and you do not include it in the cash flows. Renovation capital sits below net operating income. It is a cash outflow in years one through three and it is separate from the replacement reserve that is already inside net operating income. Those two things fund different work. ## Step 5. Exit and returns Capitalize year-six net operating income at the exit cap, take off costs of sale, and that is gross proceeds to the deal. For the levered case, subtract the loan balance outstanding at the end of year five, which is lower than the original loan because three years of amortization run after the interest-only period. Then two IRRs and a multiple: - **Unlevered IRR** on the whole capital stack: outflow at closing is price plus acquisition costs, inflows are net operating income less renovation capital, plus net sale proceeds in year five. - **Levered IRR** on the equity: outflow at closing is the equity check, inflows are net operating income less debt service less renovation capital, plus net proceeds after payoff in year five. - **Equity multiple** is total distributions divided by the equity check. It counts the return of capital as well as the return on it, so a deal that gets your money back and nothing else is 1.0x, not 0.0x. ## Step 6. Form a view You now have a number for what the deal returns at the asking price. Compare it to the hurdle. If it falls short, the useful output is not "pass." It is the price at which it would clear, and the two or three assumptions that would have to be true for the asking price to work. --- ## Where the judgment actually sits The assumptions file fixes a lot so the answer is checkable. In a live deal these would be the arguments: - **How fast loss to lease is captured.** This model captures none of it in year one, which is conservative. Leases roll across twelve months, so a case can be made for capturing part of it. - **The renovation premium.** 18 renovated units is a small sample. Whether the premium holds across another 102 units is the biggest single question in the business plan. - **The exit cap.** Five years of cap rate movement is unknowable, and the exit assumption usually drives more of the IRR than anything in the operations. - **Whether reserves belong inside net operating income.** Practice varies. What matters is that you say which convention you used, because the cap rate you compute is not comparable to one struck the other way. --- *Illustrative teaching case. Northgate Commons, the market, the broker, the lender, the comparables, and every figure in this packet are fabricated for instruction. Nothing here is a real property, a real transaction, or a real financing quote.*