When it comes to real estate investing, few skills are more critical and more commonly misunderstood than underwriting.
Done well, underwriting is your compass. It guides every major decision, from acquisition to exit strategy. Done poorly, it can sink your profit before a single nail is hammered.
At Dominion Financial, we’ve underwritten thousands of deals, from quick flips to long-term rental holds, and we’ve seen firsthand how strong underwriting separates successful investors from speculative ones. Whether you’re flipping houses or building a rental portfolio, mastering the fundamentals is essential.
Let’s break it down.
The Heart of It All: Nailing Your ARV
Whether you’re flipping for profit or holding for cash flow, every investment starts with one number: After Repair Value (ARV).
This is where most investors go wrong. A solid ARV isn’t a guess; it’s a grounded projection backed by real data. Here’s how to get it right.
Use True Comparable Sales (Comps):
- Same neighborhood (ideally within a few blocks)
- Similar square footage (within ±20%)
- Recent sales (within the past 6 to 12 months)
- Comparable condition and renovation level
If you’re relying on one comp, or an outdated one, you’re building on shaky ground. Aim for at least two strong comps to validate your target value.
Once you’ve identified them, calculate the average price per square foot and apply it to your subject property’s square footage. This gives you a defensible, data-backed ARV.
Strategy First: Flip or Hold
Before running any numbers, ask yourself the most important question: Are you flipping this property, or holding it as a rental?
That single decision changes everything about your underwriting approach, including how you calculate ARV.
- Retail (flip) ARV assumes a higher standard of finish and a buyer paying top dollar
- Rental ARV often lands 5 to 10 percent lower, reflecting more modest renovations and valuation based on income potential
Flipping: Underwrite for Profit
When flipping, your goal is straightforward: buy low, renovate right, sell high. Here’s the formula experienced flippers use:
ARV – Selling Costs – Renovation – Carry – Desired Profit = Maximum Acquisition Price
Formula breakdown:
- Selling Costs: Realtor commissions, transfer taxes, and closing fees. These typically range from 6 to 8 percent of the ARV and should never be overlooked.
- Renovation: Include a 10 to 15 percent contingency to cover change orders, hidden damage, or scope creep. Even experienced investors run into surprises once the demo begins.
- Carry Costs: This includes loan interest, property taxes, insurance, utilities, and any HOA fees. These costs can eat into your margin quickly, which is why it’s critical to estimate your flip timeline accurately. If you expect a 3-month renovation but it takes 6, your carry costs double. Always budget for realistic timelines, not best-case scenarios.
- Profit: Target at least a 20 percent margin on your total project costs (purchase + renovation + carry + selling expenses). Deals rarely go exactly as planned. This buffer protects your upside when surprises happen.
Holding: Underwrite for Stability and Cash Flow
Buy-and-hold investing requires a different lens. You are not just buying a property, you are buying an income stream. Start with this formula to determine your maximum purchase price:
(ARV × LTV) – Renovation – Transactional and Carry Costs = Maximum Purchase Price
But that is only part of the equation. You also need to ensure the property generates enough income to support the debt. That is where the Debt Service Coverage Ratio (DSCR) comes in:
DSCR = Net Operating Income (NOI) ÷ Annual Debt Service
- NOI is your annual rental income minus operating expenses (taxes, insurance, maintenance, property management, etc.)
- Debt Service is your total annual loan payments (principal and interest)
DSCR Tells You:
- 1.20x or higher: Healthy cash flow with a buffer for vacancies or unexpected expenses
- 1.00x: Break-even point; rent just covers debt
- Below 1.00x: Negative cash flow; the property cannot support the loan
Even with favorable financing, a rental that barely covers its debt is a risky hold. At Dominion Financial, we recommend aiming for a minimum DSCR of 1.2x to provide a cushion against rate fluctuations, vacancies, and repairs.
Renovation Scope Equals Risk Level
The bigger the renovation, the higher the stakes. Why?
- Longer timelines increase carrying costs
- More unknowns emerge, such as hidden issues, change orders, or permit delays
- Greater exposure to market shifts over time
Underwrite conservatively. Ask the hard questions before you commit:
- What if it takes three months longer?
- What if interest rates rise before I refinance or sell?
- What if the ARV comes in lower than projected?
If your deal still holds up under these assumptions, it is likely worth pursuing.
Need a Partner Who Underwrites Like an Investor?
At Dominion Financial, we’re more than a lender – we’re investors ourselves.
Our in-house underwriting team understands what makes a deal work. Whether you’re buying your first rental or flipping your 50th home, we’ll help you run the numbers right from the start.
INVESTOR TAKEAWAYS
Underwriting is the process of analyzing a potential investment property to determine its profitability and risk. It involves assessing purchase price, renovation costs, carrying expenses, financing terms, and exit strategy to ensure the deal meets your target return before you ever close.
ARV represents what a property will be worth after renovations are complete. It’s the cornerstone of every investment calculation, guiding how much you can pay, how much to spend on rehab, and what profit to expect. Accurate ARVs rely on recent, nearby, and truly comparable sales, not broad market averages.
Big rehabs come with more variables – longer timelines, higher carrying costs, and greater exposure to market changes. Smart investors underwrite conservatively, running “what-if” scenarios for delays, cost overruns, and lower-than-expected ARVs. If the deal still works under stress testing, it’s likely sound.
The biggest errors include overestimating ARV, underestimating renovation costs, ignoring carrying expenses, and failing to factor in realistic timelines. Another common pitfall is not differentiating between retail (flip) ARV and rental ARV. Precise numbers and conservative assumptions are what separate professionals from speculators.
A strong deal holds up even after stress testing. Once you’ve calculated ARV, DSCR (for rentals), and total project costs, ask “what if” questions: What if repairs cost 10% more? What if the sale takes 90 days longer? What if rates rise before I refinance? If the property still meets your return and cash flow goals under those scenarios, it’s likely a deal worth moving forward on. Solid underwriting isn’t about optimism – it’s about resilience.
