In the October Issue
- What is a Value-Add Property?
- How Value-Add Deals Compare to Retail Deals
- Life-Cycle of a Value-Add Property
- How to Enter the Value-Add Space
Could Value-Add Deals be Your Next Wealth Builder?
A look into how value-add projects in real estate are generating strong returns for investors.
Flipping houses has been the craze within the real estate space in recent years due to increased publicity from TV shows. Investors buy a dilapidated house, flip it, and sell it at full market value making making a big profit.
Most of the time, these TV personalities are flipping single-family homes, but what do value-add projects look like in the multi-family housing space? These projects are harder to find but quickly turn into money making machines with the right management and capital.
This month, we are going to explore the concept of value-add investing in the multi-family space and how these types of projects differ to retail deals. We will walk you through their life-cycle and how to find them in your own market. While these deals require time and investment, they bring strong returns for any investor looking to build future wealth.
What is a Value-Add Property?
If this is your first time exploring the real estate space, you may be wondering– what is a value-add property?
In short, a value-add property is a single-family home, multi-family home, self storage, commercial property, etc. in need of internal/external upgrades. They usually have cash flow in place, but are significantly underperforming compared to what they could be generating in the area.
*Note: What does underperforming signify? Value-add properties typically have an occupancy rate between 50-80% before value is added. High-performing assets will have occupancy rates in the 90 percentile range.
The upside to these projects is they usually generate stronger cash flow in the end due to the appreciation in value. Investors capture that appreciation when exiting the deal in which the property is either sold or refinanced. We’ll discuss exit strategies more in depth later.
So how can you force appreciation to eventually sell the property at market value?
Four Ways to Increase Your Property’s Value (and Cash Flow Opportunities)
- Physical Upgrades
- Better management
- Additional Service Facilities
- Improved Marketing
Any upgrade, renovation, or remodeling will add long-term value to a property. This might include new appliances, kitchen cabinets, flooring, or repainting. External upgrades could be new roofing, new siding, or upgrades to common areas like gyms, pools, or clubhouses.
Many properties are in fairly good condition but are poorly managed leaving occupancy rates lower than average. By bringing in better management, you could increase your occupancy rates and lower your costs.
Another way to add value to a multi-family space is adding services on the grounds (i.e. laundry facility). Depending on the type of service, it could also be another cash flow opportunity for you.
Marketing an apartment complex as a low-rent housing option when in fact the area supports higher rents may not be the best move. By improving your marketing, you could change the composition of your tenants and increase rents across the board.
There are so many ways to add value to a multi-family space. It’s one of the few reasons why investing in value-add opportunities can result in strong cash for investors. Let’s explore, however, the difference between retail deals and value-add projects to better understand the opportunity with value-add properties.
Retail Vs. Value-Add: Which is Better?
To begin, what defines a retail deal? They are fully stabilized, cash flowing properties sold on a capped rate based on strong operating cash flow and a history of good operation. They are priced (and sometimes overpriced) at full market value.
It’s easy to obtain financing for these deals because they have high occupancy, good operation, and line of credit. Not to mention, they are easier to find because real estate brokers are selling them everywhere, in every market.
On the other hand, you are getting a bargain with a value-add property. These properties are priced at a steep discount to fair market value because they are usually in poor condition, run down, or mismanaged (like we mentioned before).
Unlike retail deals, there is significant upside potential or better yet, higher forced appreciation with value add properties because there is room for added value through renovations, remodeling, or upgrades.
*Investor Note: What about ROI? There is little room to increase ROI on retail deals because these properties are usually already in good condition and yielding strong cash flow. With value-add properties, there is room to increase ROI because these projects can be bought with leverage and sold at a fair market value after renovations are complete.
Another difference between retail and value add projects is their exit strategies. With retail deals, you may not be able to refinance or cash out if appreciation doesn’t occur. If you buy a property at market value and the market overcorrects, you overpaid for the property and might have a hard time selling it at the price you want.
Value-add properties typically have dual exit strategies. First, you could sell the property upon full stabilization. Secondly, you could refinance and cash out your initial investment to pay back investors. Both strategies offer strong returns with added security.
Life Cycle of a Value Add Project
It’s apparent there is more upside potential with value-add properties compared to retail deals for investors. If you decide to invest in multifamily value-add properties, the next step is understanding their life cycle from acquisition to exiting the deal.
A typical life cycle of a multi-family value-add project is 3-5 years. It begins with the project sponsor finding a property with strong potential and promising returns. *A project sponsor is an experienced party with a good track record in similar deals. These types of properties are difficult to find and require due diligence on the project sponsors’ end.
One way project sponsors find deals is through various marketing methods like networking with property owners, emailing, advertising on Google or Facebook, etc.
*Investor Note: There are a variety of situations to look out for when identifying your target audience. For example, property owners in a distressed situation, experiencing a lack of capital, retiring, or a recent death are more likely to have a value-add property to sell.
Once the project sponsor has found a project, they conduct a deal analysis and negotiate a price with the seller.
After the deal is approved, the next step is financing the deal and raising the initial capital from investors. As soon as capital is raised and closing occurs, renovations can begin.
The first type of renovation to complete are external renovations. This includes roofing, exterior wall work, painting, etc. These types of renovations should happen before unit renovations since it’s important to make sure the exterior of the property looks nice and attracts new tenants with the disposable income you want to target.
Once external upgrades are complete, the next phase is unit renovation. These renovations can be scheduled over a longer period (possibly a year and a half). As each unit gets renovated, they will hit the market and cash flow will begin. The good thing about a gradual unit renovation process is that expenses will incur gradually and not all at once.
Unit renovations might include updating appliances, kitchen cabinets, flooring, carpet, or painting.
Example: Units in an Atlanta apartment rent for $1,000/month. They undergo renovation and upon completion, the monthly rent increases by $200 bringing the monthly income to $1,200/ unit. If we use a cap rate of 10, the value of the property increases to $24k or $30k by simply increasing monthly rents by $200.
Finally, when the property has reached full stabilization, the project sponsor will exit the deal and pay back investors.
*Investor Note: If you plan on investing in one of these properties, it’s necessary to work with a project sponsor you know and trust. They will take the project through its life cycle and are responsible for the completed renovations.
A Look at Cash Flow Year to Year
So when will cash flow increase during the life cycle of a value-add project?
Let’s take a look.
Once renovations are made on the property (both externally and internally), cash flow will start to increase as as you raise monthly rents and increase occupancy. By year 5, rent prices have typically reached fair market value which is when the project sponsor will exit the deal one of two ways:
- The first exit strategy is by selling the property at market value. Like we mentioned, project sponsors acquire these multi-family housing units at a bargain, so the opportunity for a strong ROI is plausible with these types of investments.
- The second option is to refinance the property and take out the capital invested in the property while the remaining equity stays. At this point, the project sponsor will pay back investors.
The dual exit strategy is an attractive benefit of value-add properties because it offers a level of security for investors– a luxury most retails deals do not have.
How TF Management Group LLC Participates in Value-Add Deals
It’s true that multifamily value-add deals require time and energy to yield strong ROI. Not to mention, there is a capital requirement needed for any investment (materials, labor, time, initial investment, etc.) If you don’t have the spare time or resources to individually invest in this type of project, there is a passive investment option for you.
Investing in a fund like the Tempo Opportunity Fund LLC is a great way to diversify your investments and yield strong cash flow without lifting a finger.
At TF Management Group LLC, we have been investing in value-add deals for awhile and have secured relationships with some of the best project sponsors in the space. Because of our reliability of capital and expertise, we have become a preferred source of capital for many sponsors over the years.
If you would like to learn more about the Tempo Opportunity Fund LLC and the types of projects we invest in, visit www.https://tempofunding.com/investors/ or contact us and we would be happy to walk through opportunities to invest.
Thanks for reading,
CEO, TF Management Group LLC
This newsletter and its contents are not an attempt to sell securities, nor to sell anything at all, nor provide legal, nor tax accounting, nor any other advice. The presenter is a private lending and real estate fund management business, and the information represented herein are purely for educational purposes and represents the opinions of the presented. Prior to making any investment or legal decision you should seek professional opinions from a licensed attorney, and a financial advisor.
TF Management Group LLC (TFMG) is an investment fund management company that specializes in both short-term debt financing for real estate “fix and flip” projects, and long-term “value-add” equity deals.