How To Make Commercial ‘Value-Add’ Real Estate Syndications Work For You

by | Jul 14, 2022 | Investing Advice

Picture yourself driving home one day and finding a free dining table at the end of a driveway. It’s worn but well made, so you load it up and take it home. 

You take a few days to do some sanding, apply stain, polish it up and proudly place the table in your dining room. 

After a few years, you decide to redecorate, so you sell the table to your neighbor, who has been admiring it all along.

You took that run-down table, took the time and effort to spruce it up, and made money on it with the sale. This is basically how value-add works. This type of strategy is frequently used when investing in real estate. 

The Basic Principles of Value-Add Real Estate

 

The “fix-and-flip” method is used in single-family home investing. You buy a property that needs improvements. You fix it up and sell it for profit. Your work is rewarded by the gain in equity, and the new homeowner has an updated, beautiful space.  

Similarly, value-add multifamily real estate works the same way but on a much larger scale. Instead of taking a few months to renovate a single-family home, a hundred-unit complex is upgraded over a few years. 

Ideal value-add properties need a new coat of paint, new appliances, and a landscaping facelift to improve the property’s desirability. Just making minor improvements can allow you to increase your rental revenue and attract better renters.

In value-add properties, improvements have two goals:

  1. Improve the unit and the community (positively impact tenants)
  2. 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 the renovation schedule and logistics aren’t as intuitive when it comes to hundreds of units at once. 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. For example, 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 glad 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 move away, and projects need 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. For example, we provide tenants with a more aesthetically pleasing property with updated appliances and more attractive community space through renovations. 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 an excellent strategy for investors.

 

First, What is a Yield Play?

 

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 the monthly cash flow and potential future profits. 

Yield Play investments are where a cash-flowing property is purchased. The property provides a recurring income stream from the rents collected. There is no business plan to renovate, force appreciation, improve the asset and realize a significant gain. Yield Play investors hold property in anticipation of market increases, but there’s always the chance of experiencing a flat or down market instead. A Yield Play is another strategy in Multifamily investing.

 

Now, Let’s Get Back to Value-Adds

 

Value Plays and Yield Plays are different. For example, in a value-add investment, significant work (i.e., renovations) increases the property’s value, which carries a level of risk. 

However, value-add deals also have potential upside since the investors hold all the cards. By making updates that improve the property and increase its value, value-add investors don’t just keep the asset hoping for market increases; they force increases through improving the asset, raising rents, and lowering expenses. 

Through property improvements, income is increased, thus also increasing the equity in the deal (remember, commercial properties are valued based on how much revenue 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, cash on cash yields are high, and the market increases simultaneously. Investors control 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 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 – this proves the concept for a particular project)
  • 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 essential – to protect investor capital at all costs.

 

So, Are Value-Add Multifamily Syndications Right For You?

Despite the risks, the opportunity to invest in something that supports growth for both the community AND investors is enticing. The Village Capital Partners team is careful to consider conservative projections and ensure risk-mitigation strategies are in place. However, we all know that investments can never be risk-free.

It’s easy to get lured into the fix-n-flip magic on HGTV and begin to believe that flipping houses is easy and consistently successful (not true), you can be easily swayed by well-designed marketing brochures and great-sounding plans for a syndication deal. However, we’re here to teach you how value-add real estate syndications work, stress the importance of a strong sponsor team (that’s us!), and provide details about risk mitigation. 

Only you can decide if value-add real estate syndications are a good fit for your goals. Before you make any significant capital moves, it’s crucial that you are educated about the process, the returns structure, and the risks. We love multifamily value-adds because the opportunity to improve tenants’ living conditions and make profit for our investors is a solid Win-Win. 

If you’re ready to chat with us about how to invest and discover which opportunities align with your goals, we encourage you to join the Village Capital Partners Investors Club. Once inside, we’ll get to know you and your specific financial objectives so we can present deals that support them.

0 Comments