2–4 units: the residential on-ramp
Owner-occupant buyers can use FHA (3.5% down) or conventional loans on 2–4 unit properties, and lenders can count a portion of the other units' rent toward qualifying income — the “house hack.” Investor (non-occupant) loans on 2–4 units need larger down payments. Because these are underwritten like homes, comps matter more than cap rate — but you should still build the income statement.
5+ units: commercial financing
Commercial and DSCR lenders underwrite the property: NOI must cover the debt service with a cushion (lenders commonly look for a DSCR around 1.20–1.25×), down payments of roughly 25–35% are typical, terms are shorter with balloon or reset features, and prepayment penalties are common. Your personal income matters less; the building's does more. Get a term sheet from a commercial lender before you offer so your DSCR math matches theirs.
What to underwrite (and how sellers shade it)
- Rents: use the actual rent roll, verified by leases and estoppels. Treat “market rent” upside as a bonus, not the basis.
- Vacancy and management: use market vacancy and a management fee even if you'll self-manage.
- Property tax at your price: Prop 13 reassessment resets the bill — recompute at roughly 1.1–1.25% of your purchase price plus assessments.
- Insurance: get a real quote in due diligence; premiums have moved a lot in parts of the state.
- Capex reserve: roofs, plumbing, water heaters, and any seismic-retrofit ordinance obligations (soft-story programs in Los Angeles, San Francisco, and other cities).
- Then compute NOI, cap rate, DSCR, and cash-on-cash. (See the three numbers explained.)
Check the rent rules before you fall in love
California's Tenant Protection Act (AB 1482) caps annual increases and requires just cause for many buildings 15+ years old, and local ordinances can be stricter (Los Angeles RSO covers most rentals built before October 1978; San Francisco, Oakland, and others have their own). These rules define your actual upside — a building with long-term tenants far below market may never reach “market rent” on your timeline. Owner move-in rules also vary. Know exactly which rules apply to each unit before you price the deal.
Due-diligence checklist
- Leases, rent roll, estoppels, deposit ledger · trailing 12 months of income and expenses · utility bills · service contracts
- Interior inspection of every unit (not a sample) · roof, sewer lateral, electrical panels, plumbing type
- Permits and open code cases · zoning and legal unit count (unpermitted units are a real risk)
- Insurance quote · property-tax recompute · lender term sheet · a CPA conversation about depreciation and entity structure