The value-add investment strategy has been a greatly successful approach for many of us multifamily syndicators. This asset class typically provides a larger return on investment, but also requires more work. And as value-add apartment investing has become more popular among investors, it has also become difficult to find a property that has been untouched since being constructed, with many properties having already undergone some renovation projects. Needless to say, finding value-add real estate nowadays requires a strong ability to identify opportunities to add value.
In a recent conversation with Jorge Abreu, multifamily investor, and construction company owner, we had an in-depth discussion about value-add multifamily investments. He walked us through various aspects of value-add planning and execution and gave valuable insights on strategies that you may overlook as a syndicator. Let me share some lessons from that conversation here and let’s learn how a syndication team can add value to such large properties, what it takes to raise the property value systematically, and how this process benefits tenants and investors alike. You may listen to the full podcast episode here.
What is a Value-Add Deal?
There are two main strategies when buying multifamily properties: turnkey and value- add. Turnkey investment focuses on newer, class A, top-condition properties that do not need significant physical changes to operate profitably. Value-add investments, on the other hand, focus on properties that require improvements and other strategies to bring out their optimum value and increase profitability. Strategies for adding value to the property may include individual unit upgrades, exterior, and shared spaces rehab, and increasing efficiencies. These strategies allow the property to achieve great value for the investor by either increasing rent (and your income) or by reducing operating costs and optimizing expenses (more savings). Hence, value-add deals offer more opportunities for investors to make greater profits.
What can be considered a value-add property?
At this point, it’s best to define what an actual value-add property means. Keep in mind, too, that not every property is suitable for a value-add plan. You might have encountered brokers offering you a “value-add deal” only to show you pictures of a newly built property. So, what does value-add mean when we’re talking about properties?
Jorge categorizes value-add properties based on the projected amount needed to renovate a unit and optimize rent. “Something above $5,000 a door is when you start getting closer to that value-add and then heavy value-add is probably $10,000 a door. It’s when you’re really going in there and you’re doing major upgrades. If it’s an older building, then it needs all new roofs. But adding a backsplash or adding a fence to a yard – that’s not a value-add,” explains Jorge.
Common value-add renovations can include individual unit upgrades such as fresh paint, new cabinets, new countertops, new appliances, new flooring, and upgraded fixtures. Adding value to exteriors and shared spaces that increase the sense of community may include: fresh paint on building exteriors, new signage, landscaping, dog parks, gyms, pools, clubhouse, playgrounds, and covered parking. Increasing efficiencies such as green initiatives to decrease utility costs, shared cable, and internet also add value.
Deferred maintenance vs. Value-add upgrades
Now, it’s crucial to explain the difference between deferred maintenance and value-add upgrades. Deferred maintenance refers to basic and necessary maintenance, repairs, and replacements that were put on hold by the property owner frequently due to budget limitations or lack of funds.
“If you’re a passive investor and you’re going to invest into a heavy value-add asset, make sure you ask your sponsor how much money is going toward deferred maintenance and how much is for the upgrades. The upgrades are going to get you more income,” says Jorge.
While it is justifiable to allocate an adequate budget toward deferred maintenance items, fixing or replacing broken parts or materials in the building (broken windows, railings, carpentry, etc.) will not justify rent increases. Jorge recommends setting aside ample money for value-add upgrades that will raise the market value of the whole property, increase the property’s income and maximize investor returns.
The value-add process
Jorge outlines the process of planning and executing value-add plans below.
Before closing: during the due diligence period
- Assemble a team of professionals to check the property: roofs, building foundation, drainage, plumbing, electricals, sewer lines, etc.
- Walk/inspect every single unit with your team. Identify down units and vacant units.
- Check the deferred maintenance list.
- Proactively identify possible value-add projects. Consider all items that can affect value-add budgets. Define the scope of work. Create a value-add plan.
One week before closing
- Hold a pre-construction meeting with your team and the construction company executing your deferred maintenance and value-add projects.
- Prioritize project activities upon property takeover.
- Get construction materials ready.
- Closing day (Property takeover)
- Execute plan on day one.
“Day one, we’re executing that plan. No time is wasted. In other projects, I’ve seen months go by after closing, and nothing’s been done to the property. No upgrades, no deferred maintenance, the scope of work is still getting figured out and then you end up spending more money than you should have which affects your returns,” says Jorge.
- Start with deferred maintenance.
Jorge defines this as hardening the property, which may include the following: replacement of leaking roof, fixing major plumbing issues, or replacement of boilers, sewer lines, and AC units.
“Starting with these items will show the tenants that the new owner is serious about taking charge and taking care of things that bother them. They’ll feel much better where they live. It turns everything around,” says Jorge.
- Then, begin with the first batch of interior unit renovations.
- Exterior rehabilitation follows.
“Success in the value-add process comes down a lot to your team. Make sure you have the right team by your side and that you know exactly what you are getting into. But also, you have to make sure to implement the right systems,” ends Jorge.
While no investment is totally risk-free, value-add investments can be powerful vehicles of wealth that provide excellent benefits to the community and investors alike. The ability to identify ways to add value and execute your strategy according to plan will be the driving force of your multifamily value-add investment. So, sharpen those skills and make the most of your next investment opportunity.