Value-Add Real Estate

Table of Contents

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 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 commercial real estate deals follow a similar model, but on a much larger scale. For a hotel, all of the rooms and restaurant get a facelift.  For a warehouse, maybe the roof is replaced and outside concrete is repaired.  For multi-family, 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A great value-add property may have peeling paint, outdated appliances, or overgrown landscaping, which all affect the curb appeal and the initial impression that a potential renter will form.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 for a multi-family deal 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. How do you renovate property while people are living there and how many units can be improved at a time?

When renovating a multifamily property, vacant units are done 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 than 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.

 

Value Add vs 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 largely dependent upon the market.

 

The Benefit of 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.

Value-add deals come with lots of potential upside since the investors hold all the cards. Physical improvements to the property increase its value are not relying solely on market increases.

Improvements also mean higher rents, thus also increasing the valuation of the property (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.

But of course there are risks.


Risks 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 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.


Recap and Takeaways

No investment is risk-free. However, when something, despite its risks, provides great benefits to the community AND investors, it can be quite attractive.

Properly leveraging investor capital in a value-add investment allows drastic improvements in apartment communities, thereby creating a cleaner, safer place 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.


Prevail Innovative Real Estate Opportunities, LLC., (PREO) is affiliated with Prevail Wealth Advisors, LLC (Prevail IWA) and Prevail Strategies LLC., because they are under common ownership and control. PREO was formed to provide real estate investment opportunities for high-net worth investors looking for diversification. Prevail Wealth Advisors, LLC., is a federal registered investment advisor. Registration with any securities authority is not an endorsement of the services offered by the investment adviser. Fixed insurance products and services are offered through Prevail Strategies, LLC., a licensed insurance agency. Any investment by a Prevail IWA client into a PREO sponsored real estate investment would be without the involvement of Prevail IWA and should be not seen a s a recommendation by Prevail IWA. Additionally, Prevail IWA clients should realize that any capital they invest in a PREO-sponsored real estate investment would be completely outside of their advisory relationship with Prevail IWA and not part of their Prevail IWA account going forward. Finally, there are material differences between the type of investments PREO may offer and the investments on which Prevail IWA provides advice in terms of risk profile and liquidity, and the compensation PREO earns from a real estate project in which Prevail IWA clients invest may be materially different than the investment advisory fees Prevail IWA charges its clients.
An offer or solicitation to acquire interests in the investment may only be made by our Private Placement Memorandum (“Memorandum”) in accordance with the terms of all applicable security laws. All information contains herein is subject to and qualified by the contents of the Memorandum. Participation in any securities offering is limited to Accredited investors. Please call to obtain a copy. You must read it before investing. Past Performance is no guarantee of a future results. An Offer to buy or sell any security is only made by our Private Placement Memorandum. Prevail Real Estate Opportunities, LLC., Prevail Innovative Wealth Advisors, LLC., and Prevail Strategies LLC., do not provide tax or legal advice.  You should your CPA or tax professionals for decisions involving tax implications present and future.

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Value-Add Real Estate

Frequently Asked Questions

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Andrew Stafford

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