How Value-Add Multifamily Real Estate Syndications Work

by | May 21, 2021 | 0 comments

You can’t tell me you’ve never spotted some discarded old thing, decided there was probably more than what meets the eye, and proceeded to lug it home to refurbish it! We’ve all done this, right?

I’ll never forget a few years ago when I noticed this cute old bookshelf sitting out on the curb. I hesitated but just couldn’t pass it up. I pulled over to check it out, and since it was in good shape, I took it home, sanded it a little, and repainted it. 

Something about refurbishing the bookshelf gave me such satisfaction, and it fits perfectly in the corner of my office. A few years later, we decided to relocate to Texas, and I sold it to this sweet woman who claimed to have the perfect spot. That sense of accomplishment, the pride that I’d spotted this diamond in the rough, and the simple pleasure of reusing something so useful flooded my emotions again.

I took something overlooked, committed some sweat equity, and breathed new life into it. This is the essence of value-add real estate, and it’s a commonly used strategy across the board in real estate investing. 

 

The Basics of Value-Add Multifamily 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 and multiple shared spaces across the property get renovated over a few years instead of just one single-family home over a few months. 

An opportunity-filled value-add property may have peeling paint, outdated appliances, or overgrown landscaping, all of which affect the curb appeal and the initial impression that a potential renter will form. Simple cosmetic upgrades and modern conveniences can attract more qualified renters and increase the property’s income, improving occupancy and growing revenue. 

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 Investment

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 live there and how many units can be improved at a time. 

When renovating a multifamily property, the vacant units are first. No one’s ever kicked out of their apartment so that renovations can take place. For example, in a 100-unit complex, a 5% vacancy rate means there are five empty units 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 glad to pay a little extra. 

Once tenants vacate their old units, renovations ensue, and the process continues to repeat over 1-3 years until most or all of the units have been updated. 

Some tenants move away during this process, and projects need to account for a temporary increase in vacancy rates due to turnover and new leases. At the same time, the renovated units attract new tenants that wouldn’t have typically considered an older property. There’s always ebb and flow.

 

Why We Love Investing in Value-Add Properties

When done well, value-add strategies benefit all parties involved. We provide tenants a more aesthetically pleasing property with updated appliances and more attractive community space through renovations. It makes sense to pursue green initiatives in some locations, install eco-friendly features, or modernize efficiency technology on the property. The property becomes more valuable, allowing higher rental rates and increased equity, making investors happy. 

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 an excellent strategy for investors.

 

First, Yield Plays

To fully appreciate value-add investments, we must first understand their counterparts, yield plays. Investors buy a stabilized asset in a yield play and hold it for the monthly cash flow and potential future profits. 

Yield play investments are where a currently cash-flowing property that’s in decent shape is purchased.  The property provides a recurring stream of income from the rents collected – the yield.  There is an expectation of selling it for a small profit. Still, there is no business plan to renovate, force appreciation, improve the asset and realize a more significant sale. 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. 

Now, Let’s Get Back to Value-Adds

Value plays and yield plays are different. In a value-add investment, significant work (i.e., renovations) increases the property’s value, and making such improvements carries a 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. They force increases through improving the asset, raising rents, and lowering expenses. 

The property manager increases income through property improvements and resultantly improves the equity in the deal. Remember, income generation is the value basis for commercial properties, not comparables like single-family homes. Value-add allows investors much more control over the investment than in a yield play. 

Of course, a hybrid yield + value-add investment is ideal. A hybrid or mixed investment is where an asset gets improved, cash-on-cash results are high, and 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 at the forefront of the plan and who have several 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 capital for budgeted 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. Risk mitigation strategies are essential in value-add investments – to protect investor capital at all costs.

 

How To Grow Your Wealth With Value-Add Multifamily Real Estate Syndications

No investment is risk-free. However, it becomes pretty attractive when something, despite its risks, provides excellent community and investors benefits. 

You do your homework upfront, vetting and learning about real estate markets in which you might be interested. Then we help you find a deal in alignment with your personal investing goals.

Meanwhile, we properly leverage investor capital in our value-add multifamily real estate investment, allowing drastic improvements in the apartment community, thereby creating a cleaner, safer place to live and making tenants happier. 

It’s a win-win! You earn returns while playing a part in improving the property while tenants enjoy an updated residence and embody a sense of pride for their community. 

Because investors (you) have control over what type of value-add real estate investment they select, rather than relying solely on market appreciation, they have more options when it comes to safeguarding capital and maximizing returns. 

Join the Starboard Equity Club, where you can explore different value-add deals, learn more about returns and investors’ experiences on our past syndications, and receive guidance on your next real estate syndication investment selection!

 

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