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An In depth Look at Value Add Investments

by | Feb 3, 2021 | Apartment Investing, Passive Income, Real Estate Syndication | 0 comments

Imagine spotting an old bookshelf sitting out on the curb. You pull over to check it out, and since

it’s in good shape, you proceed to lug it home and give it a fresh coat of paint.

A few years later, you sell the shelf to someone else who claims to have the perfect spot for it.

You took something that had been overlooked, committed some sweat equity, and breathed

new life into it. This is the essence of value-add, and it’s a commonly used strategy in real

estate investing.

The Basics of Value-Add Real Estate

In the case of single-family homes, the process of buying a run-down property, remodeling it,

and then selling it for profit, is commonly referred to as fix-and-flip. Your sweat equity and ability

to see a diamond in the rough is rewarded monetarily, and the new owner gets an updated,

move-in ready home.

Value-add multifamily real estate deals follow a similar model, but on a massive scale.

Hundreds of units get renovated over years at a time instead of just one single-family home over

a few months.

A great value-add property may have peeling paint, outdated appliances, or overgrown

landscaping, which all affect the curb appeal and the initial impression that a potential renter will

form. Simple, cosmetic upgrades can attract more qualified renters and increase the income the

property produces.

In value-add properties, improvements have two goals:

1) To improve the unit and the community (positively impact tenants)

2) To increase the bottom line (positively impact the investors)

Value-Add Examples

Common value-add renovations can include individual unit upgrades, such as:

● Fresh paint

● New cabinets

● New countertops

● New appliances

● New flooring

● Upgraded fixtures

In addition, adding value to exteriors and shared spaces often helps to increase the sense of

community:

● Fresh paint on building exteriors

● New signage

● Landscaping

● Dog parks

● Gyms

● Pools

● Clubhouse

● Playgrounds

● Covered parking

● Shared spaces (BBQ pit, picnic area, etc.)

On top of all that, adding value can also take the form of increasing efficiencies:

● Green initiatives to decrease utility costs

● Shared cable and internet

● Reducing expenses

The Logistics of a Multifamily Value-Add

The basic fix-and-flip of single-family homes is pretty familiar to most people, but when it comes

to hundreds of units at once, the renovation schedule and logistics aren’t as intuitive. Questions

arise around how to renovate property while people are living there and how many units can be

improved at a time.

When renovating a multifamily property, the vacant units are first. In a 100-unit complex, a 5%

vacancy rate means there are five empty units, which is where renovations will begin.

Once those five units are complete and as each existing tenant’s lease comes due for renewal,

they are offered the opportunity to move into a freshly renovated unit. Usually, tenants are more

then happy with the upgraded space and happy to pay a little extra.

Once tenants vacate their old units, renovations ensue, and the process continues to repeat

until most or all of the units have been updated. During this process, some tenants do move away, and it’s

important for projects to account for a temporary increase in vacancy rates due to turnover and new

leases.

Why We Love Investing in Value-Add Properties

When done well, value-add strategies benefit all parties involved. Through renovations, we

provide tenants a more aesthetically pleasing property, with updated appliances and more

attractive community space. By doing so, the property becomes more valuable, allowing higher

rental rates and increased equity, which makes investors happy too.

The property-beautification process and the fact that renovated property is more attractive to

tenants is probably straightforward. But let’s dive into why value-add investing is a great

strategy for investors.

First, Yield Plays

To fully appreciate value-add investments, we must first understand their counterparts, yield

plays. In a yield play, investors buy a stabilized asset and hold it for potential future profits.

Yield play investments are where a currently-cash-flowing-property that’s in decent shape is

purchased and held in hopes to sell it for profit, without doing much to improve it. Yield play

investors hold property in anticipation of potential market increases, but there’s always the chance of

experiencing a flat or down market instead. 

In a yield play, everything is dependent upon the market.

Now, Let’s Get Back to Value-Adds

Value plays and yield plays are the opposite. In a value-add investment, significant work (i.e.,

renovations) takes place to increase the value of the property and doing such improvements

carry a significant level of risk.

However, value-add deals also come with a ton of potential upside since the investors hold all

the cards. Through physical action steps that improve the property and increase its value,

value-add investors don’t just hold the asset hoping for market increases.

Through property improvements, income is increased, thus also increasing the equity in the deal

(remember, commercial properties are valued based on how much income they generate, not

on comps, like single-family homes), which allows investors much more control over the

investment than in a yield play.

Of course, a hybrid yield + value-add investment is ideal. This is where an asset gets improved

as the market increases simultaneously. Investors have control over the value-add renovation

portion and the market growth adds appreciation.  

Now, before you get too giddy about the potential of a hybrid investment, there are risks associated with

any value-add deal.

Examples of Risk in Value-Add Investments

In multifamily value-add investments, common risks include:

● Not being able to achieve target rents

● More tenants moving out than expected

● Renovations running behind schedule

● Renovation costs exceeding initial estimates (which can be a big deal when you’re

renovating hundreds of units)

Risk Mitigation

When evaluating deals as potential investments, look for sponsors who have capital preservation of the

forefront of the plan and who have a number of risk mitigation strategies in place. These may include:

● Conservative underwriting

● Proven business model (e.g., some units have already been upgraded and are achieving

rent increases)

● Experienced team, particularly the project management team

● Multiple exit strategies

● The budget for renovations and capital expenditures is raised upfront, rather than through cash flow

Value-add investments can be powerful vehicles of wealth, but they also come with serious

risks. This is why risk mitigation strategies are important – to protect investor capital at all costs.

Recap and Takeaways

No investment is risk-free. However, when something, despite its risks, provides great benefits

to the community AND investors, it becomes quite attractive.  Properly leveraging investor capital in a

value add investment allows drastic improvements in apartment communities, thereby creating a cleaner,

safer places to live and making tenants happier.  Because investors have control over how and when

renovations are executed, rather than relying solely on market appreciation, they have more options when

it comes to safeguarding capital and maximizing returns.

Sounds like a win-win!

Want to Learn More?

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