Getting Your Hands Dirty with Value-Add
We have all seen the shows on TV where people will take a run-down or neglected house, renovate it, and put it back on the market to sell it at a higher price, oftentimes for a profit. As you know, this strategy is referred to as flipping houses, in which you find an opportunity to renovate a property to create additional “sweat equity”. This same strategy applies in the world of apartment investing, but on a much larger scale.
Using the value-add strategy in apartment investing, an investor, or investment group, will find an older apartment community, identify a shortfall in the asset to capitalize on, purchase the property, and renovate the property to increase the rents, lower expenses to increase the net income of the property, and eventually put it back on the market to sell it at a premium.
A value-add property will have cosmetic issues such as poor landscaping, outdated cabinets, peeling paint on the building, etc. Adding value can also come in the form of decreasing expenses and making adjustments to property management, driving some of the quickest growth in net operating income. One thing you don’t want to do is confuse deferred maintenance (extensive roofing issues, replacing all the siding, etc.) with value-add opportunities because even though these issues may make the property look less attractive and impact occupancy, fixing these issues may not result in a predictable and direct increase in rental rates. Addressing value-add issues that make financial sense, will not only provide the tenants with better housing, it will also increase the owner and investors’ bottom line.
How A Value-Add Apartment Syndication Works
Purchase the Property: The syndicator will start locating apartment communities in their target market with the help of local real estate professionals, do underwriting and due diligence on the apartment community of interest, propose the deal to investors and raise funds, and then acquire the asset.
Add Value: This is where the fun (and sometimes stress) begin. If a new property management team is part of the business plan, then they will be put in place and then the renovations will start. Renovations will start almost immediately after the property is purchased, starting with the vacant units and exterior and/or common areas, if that is part of the business plan.
As leases on the occupied units come to an end, tenants will be offered an upgraded unit if available, however, the business plan and projection should take into account a temporary increase in vacancy during renovations. This process can last anywhere from a couple of months for lighter renovations, to 12-18 months for heavy value-add projects.
Refinance (Optional): Once the majority of the value is added into the property, and revenues are increasing, sponsors will often seek a refinance. Based on the new revenues, the property will likely receive a higher appraisal value. A supplemental loan can then be put in place for that additional equity, which means investors get a chunk of their original capital returned.
For instance, if you invest $75,000, and 20 months go by, and the property is refinanced, the passive investors receive 40% of their initial investment, which mean that you get $30,000 back out of your initial $75,000 investment within the first 20 months. The best part is that even after getting 40% of your initial investment back, you still get cash flow as if you still had $75,000 invested.
Refinances are not guaranteed and many syndicators don’t include this in their business plan, using it as an added bonus if they do choose to refinance.
Hold the Property: In this stage, the partnership will “sit” on the asset and collect cash flow, as one would a regular, stabilized apartment. The typical hold period from acquisition to sale in multifamily syndication is 5-7 years, depending on the deal. The partnership will capitalize on the common 2-3% market rent increases to increase the revenue and appreciate the property.
Sell: The property is sold, either on the market or off the market, return the investor’s remaining initial capital and their distribution of any profit generated at the sale of the property. Investors will then have their initial investment plus profit to roll over into other syndication deals.
An Example of the Numbers Behind A Value-Add Deal
Dwellynn buys a 130-unit apartment complex for $7.6 million
Most of the units are rented out at $730/month
Comps show market rent for similar newly-renovated apartments to be $850-$950/month
We plan to renovate each unit for $5,500/unit and raise the rent to $830/month
Once the units are renovated the gross income, taking into account vacancy, will be around $1,245,000 ($830 x 125 rented units x 12 months)
If $560,250 or about 45%, of the gross income, goes to operating expenses, the net operating income (NOI) will be $684,750.
If you divide the NOI by the average cap rate for a similar property in the same market, let’s say 7%, the new property value would be around $9.7 million, which is an increase of $2.1 million. If the cost of the renovations was about $720,000, the net profit would be $1.38 million.
Identifying the Risks and Limiting Your Exposure to the Risks
As with any investment, there are some risks associated with passively investing in value-add apartment syndications:
Falling short of the target rents
Higher vacancy rates than previously expected
Renovations running behind schedule or going over the planned budget
How you limit your exposure to risk when you invest with Dwellynn
We make capital preservation and protecting your initial investment our #1 priority
We create plans for multiple exit strategies
We collaborate and recruit experienced real estate and related professionals to be on our team
We use conservative underwriting to evaluate our deals before we offer them to our investors to ensure that the deal won’t fall short of expectations, we don’t use aggressive projections, and we make sure to take into account the “worse case scenario”
We use proven strategies and business models, such as focusing on affordable apartment communities and using renovated units at the subject apartment community to gauge the rental potential
We raise the money needed to renovate the project upfront, instead of depending on the cash flow produced by the property
Let Us at Dwellynn Get Our Hands Dirty While You Collect the Checks
The team at Dwellynn makes it a priority to thoroughly analyze market data to identify markets and submarkets that have property values in which rental rates are affordable and projected to grow, by looking at population growth, job growth, income growth, and other factors. But value-add properties do not only rely upon continued rent growth. We know that the key to having successful value-add syndication deals is to have local, experienced team members and partners with strong market knowledge and proven track records to be the boots-on-the-ground.
We only take on deals that fit our overall business model and investing strategy and focus entirely on replicating and perfecting the process. The outcome is a value-add syndication deal in which the total project cost is lower than the purchase price of a similar newly-built or stabilized property. The renovated property will have comparable value to stabilized assets in the target market, resulting in value and profit being created for our investors.