How It Works: Value-Add Multifamily Real Estate Syndications
I heard something recently that struck me as interesting and ironic - The future you always has more free time. Consider that for a moment. We always take on tasks, hobbies, fix-it to-do lists, and more for “later.” Will you really have time for that endeavor next month or in six months? Probably not, but it is interesting how our brains are so naturally optimistic.
Along these lines - and most of us have done this before at some point - Imagine you’re cruising through your friends’ neighborhood, and you spot a lovely bookshelf sitting out on the curb. You can’t believe your eyes - that’s the perfect size for your study! So, you pull over to check it out, and since it’s in good shape, you proceed to lug it home. You don’t know how on earth you’ll squeeze this little project into your busy schedule, but something inside won’t let you pass it up.
You manage to spend a couple of hours over the next week sanding and painting this little lost-and-found item, and you nailed it - it’s the perfect fit, right next to your most comfy chair. A few years later, you pass the shelf to someone else who claims to have the ideal 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.
You’ve likely heard of fix-and-flips on single-family properties, but multifamily properties require the same types of refurbishment, just on a much larger scale. In this article, you’ll learn how the syndication team adds value to such large properties while people are still living there, what it takes to raise the property value systematically, and how this process benefits tenants and investors alike.
The Basics of Value-Add Real Estate
As mentioned above, the process of buying a run-down single-family home, 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. Hundreds of units get renovated over years at a time instead of just one single-family home over a few months.
An excellent value-add property may have peeling paint, outdated appliances, or overgrown landscaping, which all affect the curb appeal and the initial impression that a potential renter will form. In addition, simple cosmetic upgrades can attract more qualified renters and increase the income the property produces.
In value-add properties, improvements have two goals:
- To improve the unit and the community (positively impact tenants)
- To increase the bottom line (positively impact the investors)
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
- Dog parks
- 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. 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.
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.
Why We Love Investing in Value-Add Properties
When done well, value-add strategies benefit all parties involved. For example, we provide tenants a more aesthetically pleasing property with updated appliances and more attractive community space through renovations. As a result, 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 yield plays, where investors buy a stabilized asset 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 a hope to sell it later for a small profit, but there is no business plan to renovate, force appreciation, improve the asset and realize a more significant gain at 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. For example, 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.
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 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)
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 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.
Why Value-Add Multifamily Syndications Might Be For You
Taking into consideration that the future you has no more free time than the current you, I encourage you to think long and hard about when and if you’ll ever really get to that next project.
Will you really buy a rental property within the next six months?
Will you really rebalance your 401K within the next year?
This is what makes real estate syndications so attractive. You don’t have to spend any time dealing with contractors or selecting finishes. You get the satisfaction of improving an entire community with your investment; meanwhile, your daily life is unaffected, and your free time isn’t cluttered with projects. With only a tiny time commitment upfront (like the time you’ve taken to read this article) to educate yourself and select an opportunity that aligns with your investing goals, you can establish a stream of passive income that lasts for years.
No investment is risk-free. However, it becomes pretty attractive when something, despite its risks, provides excellent benefits to the community and investors alike.
Properly leveraging investor capital in a value-add investment allows drastic improvements in apartment communities, thereby creating cleaner, safer places 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.
There are numerous risks with owning physical real estate via private placements including weather and natural disaster risks, interest rate risk, operator and business risks, and overall real estate market volatility which can effect the performance of the investments. Investing in private placement securities entails a high degree of risk, including illiquidity of the investment and loss of principal. Please read the offering document before investing.
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