What the Rate Cycle Taught Us
Between 2020 and 2022, multifamily deal flow was frothy. Sponsors were underwriting rent growth of 5-8% annually, acquiring with floating-rate bridge debt, and projecting exits at cap rates that assumed the market would only compress.
Then rates moved.
Many of those deals either missed distributions, called capital, or had to sell at a loss. The investors caught in those deals had one thing in common: they skipped the red flags.
Red Flag 1: Floating Rate Bridge Debt With No Cap
Bridge debt is fine. Floating rate bridge debt without an interest rate cap is not.
Deals that used unhedged floating rate debt in 2021-2022 saw their debt service double or triple as SOFR climbed from near-zero to 5%+. Many deals that were cashflow positive at origination became deeply negative.
What to look for: If a deal uses floating rate debt, verify the sponsor has purchased a rate cap — and check the strike rate, term, and counterparty.
Red Flag 2: Optimistic Rent Growth Assumptions
A sponsor projecting 6% annual rent growth in a market that has averaged 2% historically is not underwriting — they're wishful thinking.
Always benchmark the sponsor's rent growth assumptions against:
- Trailing 5-year actual rent growth in the submarket
- Current supply pipeline (new construction depresses rent growth)
- Job growth trends
A safe assumption: Use the trailing 5-year average, then stress-test at 0% to see if the deal still works.
Red Flag 3: Thin Debt Service Coverage Ratio
DSCR below 1.15x at stabilization is thin. Below 1.0x means the property cannot cover its debt service from operations alone.
Many 2021-era deals had pro forma DSCRs of 1.05-1.10x at stabilization. A modest shortfall in NOI (vacancy, unexpected expenses, slower lease-up) pushed them underwater.
What to check: Stabilized DSCR in the Year 3-4 projections, and what happens to DSCR if NOI is 10% below projection.
Red Flag 4: Loan Maturity During Hold Period
Bridge loans typically mature in 2-3 years. If the sponsor projects a 5-year hold, that means they're counting on refinancing the bridge into permanent debt partway through.
If the refinancing environment is hostile (high rates, tightening credit standards), the sponsor may need to sell early — often at a bad time.
What to check: Loan maturity date vs. projected exit date. There should be 12-18 months of buffer.
Red Flag 5: No Sponsor Skin in the Game
Sponsors who co-invest their own capital alongside LPs have a stronger incentive to protect principal. Sponsors who earn acquisition fees, asset management fees, and carried interest — but invest none of their own capital — have a different risk profile.
What to ask: How much of the sponsor's own money is in this deal?
A meaningful co-investment (1-3%+ of total equity) signals alignment. Zero co-investment does not mean the deal is bad, but it changes the incentive structure.
Run the Checklist Before You Sign
SkAI automatically flags these risk factors when you upload a deal document. The debt structure analysis, rent growth benchmarking, and DSCR stress tests are built into every analysis — so you catch these issues before you wire funds.