04 Nov What Is A Value-Add Multifamily Investment? Part I
Imagine finding an old piece of furniture in a second-hand shop. You know you can breathe new life into it, and make it sparkle, so you bring it home and spruce it up.
A couple of years later, you sell the piece of furniture to someone else who loves how you made this piece of furniture into something desirable, and they want it. And you sold it for more than you paid for it.
That’s a value add. You took something that was less than desirable, put in some sweat equity, and made it shine. This is what would be considered value-add, and it’s a strategy that is used frequently in real estate investing.
Let’s Go Through The Basics Of Value-Add Real Estate
With single-family homes, the process of buying a property that needs some TLC, rehabbing the property, and then selling it for profit, is referred to as a ‘fix-and-flip’. The sweat equity you put into the property and your imagination and foresight to see what this property “can be” allows you to make a profit. And the new owner is thrilled with their beautifully updated move-in-ready new home.
Value-add in multifamily real estate is the same process but on a much larger scale. Dozens, if not hundreds, of apartment units get renovations over months or years to ultimately increase the value of the entire apartment community overall.
A prime value-add property could have paint that is peeling, appliances that are outdated or not working, landscaping that is overgrown and unattractive, and on and on, all of which affect a prospective tenant’s impression of the property, which could affect the occupancy rate of the community.
Improving cosmetic upgrades on the property can attract better-qualified tenants and can dramatically increase the income that the property produces, thereby dramatically increasing the property value.
With value-add properties we have essentially two main goals:
1) To improve the individual units and apartment community overall (to positively impact the tenant experience and retention)
2) To increase the value of the property (which positively impacts the investors’ returns)
Common renovations that we perform frequently to increase the value of the property can include such upgrades as:
- New cabinets
- A fresh coat of paint
- New appliances
- New countertops
- Upgrade fixtures
- New flooring
Additionally, renovating the shared common spaces and the exterior of the building (sometimes through rebranding) can help residents feel more welcome and enable them to have a better sense of community. Some of these renovations may be:
- Fresh paint on building exteriors
- Covered parking
- Dog Parks
- New landscaping
- New or renovated clubhouse
- New signage
- Shared common spaces (picnic area, BBQ pits, seating areas and work stations etc.)
Value-add strategies can also incorporate ways to increase efficiencies such as:
- Green initiatives that can help decrease utility costs
- Shared utilities such as cable and internet
- Cost cutting strategies that reduce expenses
The Process of a Multifamily Value-Add Strategy
The concept of fixing and flipping homes is familiar to almost everyone, but the concept of rehabbing dozens or hundreds of apartment units may be an overwhelming concept for most, but this is commonly done when renovating multifamily apartment communities in a value-add strategy.
Oftentimes we get questions from investors on how we rehab a property while tenants are still living in the units and how many units we can improve at a time.
So how this works is, when we renovate a multifamily community, we renovate the units that are vacant first. For example, with a 200-unit complex, a 5% vacancy rate would mean that we have ten units that are vacant that we can begin renovating right away.
Once we have renovated those ten units then as each existing tenant’s lease expires, we then can offer them the opportunity, if they wish, to move to one of the newly upgraded and renovated units. Most tenants welcome the opportunity to live in an upgraded unit and don’t mind paying a little extra for those upgrades.
Then as tenants naturally vacate their old units over time, we then go through the rehab process on each of the units that do become vacant, and the process repeats and continues.
Why We Love Investing in Value-Add Properties
The value-add strategies we incorporate into our multifamily renovations will benefit everyone, from the tenants to the investors. These value-add strategies give tenants a much more comfortable and aesthetically pleasing place to live. And while we are increasing the value to the tenants, we also increase the value of the property for our investors, which makes for happy investors.
This is probably obvious, but let’s go into more detail about why a value-add strategy is great for investors.
First: Yield Plays And What That Entails
To appreciate why we seek out value-add investments in our multifamily investing, we want to first understand yield plays. In a yield play, investors will buy an asset that may be completely stabilized and hold the multifamily property in anticipation of any market appreciation to ultimately realize future profits.
Yield play investments are basically the strategy of taking a cash-flowing property that is in average shape then simply holding the property, doing little to no improvements to the property and hoping to sell for a profit with time. That essentially (in a nutshell) is a yield play.
We never rely exclusively on a yield play because we don’t want to bank on market appreciation. That’s a fool’s game because there’s always the chance that the market goes flat or goes down.
Everything is dependent upon the market in a yield play strategy, which is not a safe strategy that investors should rely upon.
Back to Value-Adds
Yield plays and value add strategies are two completely different concepts. In a value-add investment strategy, there can be a substantial amount of renovations that are implemented to increase the value – to force appreciation of the property. Performing renovations on a multifamily property does, however, come with some risk.
However, value-add strategies when incorporated into a multifamily community can bring an enormous amount of upside since the business plan that our team executes is thoroughly laid out. Through actively improving the property and its efficiencies we increase the value of the property – we never rely exclusively on market appreciation.
Through these renovations and increased efficiencies, the income is increased. And remember the valuation of a commercial property is based on net operating income (NOI) – not on area comparables (comps) like you would assess a single-family home. This enables the investors to have much better control over the asset than they would have if they were otherwise relying strictly on a yield play.
The best approach in our opinion is a combination of yield and value-add. An asset gets improved over time simultaneously as the market appreciates. Investors can have control of the value by forcing appreciation with the renovations while thriving market conditions can add additional appreciation.
Now, before we get too excited about the awesome aspects of a hybrid investment, we would be remiss if we didn’t say there are risks that come with any value-add strategy. We will discuss the risks in multifamily value-add investments in Part 2 of our 2-part series called “How To Mitigate Risk In Value-Add Multifamily Investments.
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