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Hi folks, this is Mike  Zlotnik, Big Mike, and today we’re going to talk about value-add investing in real estate.  Before we dive into value-add investing, I want to differentiate the terms.  There are terms such as value investing and terms such as value-add investing.  They are slightly different, but the concept is similar from the point of view that you are investing in something that will become far more valuable after some events occur, either time, improvements, or enhancements.  So you’re paying the price for something worth more.  In traditional stock market investing, Warren Buffet is one of the greatest value investors.  He would be looking for a greater value.  A great company would pay a fair price for a great company.

The same applies to real estate.  If you find an asset at a great location at a fair price, it can be a great value investing over time.  The location will take care of the business, and the property will greatly appreciate.  So value investing is simply looking for a diamond in the rough.

Sometimes you have to do something with a diamond.  You have to make it look shiny.  That’s the value-add component.  But value investing is just looking for something worth more than what you pay.  You get a great value for the price you pay, in essence, in real estate.  Value add investing adds another element.

You could buy an asset in a great location that appreciates over time.  Today’s rental market is experiencing what is known as rent inflation.  Rents are increasing over time, and you could also improve the property.  So let’s use a classic example of a value-add investment to understand better how it works in real estate.

So, value-add, investing in real estate, typically in real estate.  At least commercial property is bought based on its current net operating income.  So its current net active income will dictate the price depending on what similar assets trade at.  So if it’s a multi-family asset and it trades at what is known as a capitalization rate or a cap rate of 6%, the property makes 6 million a year, or a 6% cap rate.  Its price is a hundred million.  Now imagine that the rent on this property is low and it has yet to be renovated in 10 to 15 years.  The kitchens are old.  The appliances are old.  The carpets are old.  

These apartments look old, but they’re occupied.  The rents are low in these apartments because they’ve not been improved in many years.  An example is a property like that.  On average, the rents could be a thousand dollars a month per door today, but similar renovated property rents are much higher, like $1,400 a door.

So the opportunity is tremendous.  You could buy a property to renovate apartments internally and the property’s common areas like the clubhouse.  Siding and roof landscaping could all be improved, and these improvements could generate much higher rents.  Internal renovations could be substantial.  It could be opening floor plans, replacing carpets with hardwood flooring, changing the bathrooms with new modern tile, creating a modern medicine cabinet, or creating a modern shower.  In addition to that, kitchens could be great with great countertops, beautiful cabinets, new stainless steel appliances, and so forth.

The property would have a brand-new feel and look, but the rents are still below the market.  As the apartments are renovated, the rent could be increased substantially.  So the value-add work pushes the rents higher regardless of what the market does because the market already supports higher-end properties,

So the value-add work is simply the work of the operator on the property or the sponsor that works the property with teams.  Renovations buys all the materials, hires all the labor, and executes the value-add.  And how it enhances the properties’ potential value-add strategies could be different.

So that is an example of a value-add, multi-family we just talked about.  But let me give you another example of a different value-add work.  Value-added work, for example, on a raw piece of land that is zoned for a self-storage construction, could be getting entitlements, essentially getting the engineering drawings and the approvals from the city to build some new self-storage facility.

That work of getting the entitlements, and getting the engineering ready,  can enhance the property’s value, and the property could be sold to a developer at a much higher price.  So often, the land could be bought for a million dollars and flipped for 3 million, with entitlements and an engineering plan.

This has happened many times.  This is a value-add where an additional part of the value-add land could be bought, titled, and then a new self-storage facility constructed.  At that point, it will generate.  Upon completion, stabilization, and rent, the units would be rented.  When the property is completed and stabilized, it’s worth much more money.

An example is that land upon stabilization went from a million to 3 million, and then upon completion, another 8 million was invested in construction.  All in cost would be 9 million.  With the self-storage facility entirely operating, stabilized would be worth 17 million.  So all that is the value-add work.

And the value-add work creates value regardless of what the market does.  The market could go up, or the market could go down, but the value-adds, if executed well, can substantially enhance the property’s value.  Another example of investing in real estate value.  Imagine this is a distressed property, and you are an investor buying a distressed mortgage at a steep discount, and the bank wants to sell.

They don’t want to foreclose that title, and you bought it at 60 cents on a dollar, and you foreclose a property.  That’s the foreclosing process, and it is a value-add.  At work, it’s different, but it is not building the property.  It is not necessarily doing physical labor or doing something else.  It’s more of a legal process, but it is a value-add, and value-add varies, as I mentioned, construction, obviously development, and redevelopment.  You could take an old office building or an old hotel and reposition it to affordable housing, which has been very popular in the post covid era.  These office buildings, just people don’t want to go back in those to those office buildings, so they’re dysfunctional, poorly occupied, and need to be sold and redeveloped.

We have an affordability crisis in America, and that’s one of the strategies many folks have discussed redeveloping old office buildings into affordable multi-family housing.  Similarly, you could develop all dysfunctional hotels.  It was shut down during covid and, after reopening, is not doing well.

So the opportunity to redevelop and redevelop a hotel to multi-family is a faster process than an office to multi-family.  However, it still works, which is a value-add to all these examples.  Our value-add projects and investing in real estate quite often involve value-add.  It’s almost like this.

You could buy a performing property in great shape, fully cash-flowing, which is wonderful.  You write that property for many years on its appreciation, and it’s cash-flow.  The alternative strategy is to buy often something that’s a diamond in the rough execute value.

Increase the value substantially and then sell at a good profit.  And that’s basically how most of the values projects operate.  I hope this was helpful.  Appreciate your time and attention until the next time.  Thank you.

Summary:
Value-add investing in real estate is an attractive opportunity for those looking to increase their return on investment and benefit from rental growth due to improvements made on existing properties. This strategy involves buying assets located in ideal locations but whose condition may not be up-to-date by today’s standards, making them available at discounted prices compared to similar renovated properties. With renovations aimed at modernizing interior apartments and common areas such as clubhouses, siding, roofs, and landscaping – investors can expect higher returns through increased rents once these projects have been completed. Value-add investing is especially beneficial during periods of rent inflation, where investors can capitalize on market support for higher rents even before renovating the property itself, thus creating their own “rental inflation” within their asset portfolio.

 

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