Over the last few years, many investors have pivoted to applying a value-add strategy to increase the value of multifamily properties. Before we dive into seven ways to add value to an apartment community, let’s revisit how value is determined for an apartment.
For income producing properties, value is a function of Net Operating Income (NOI) and Market Capitalization Rate
Market Value = NOI x Cap Rate
Net Operating Income (NOI)
NOI is calculated by subtracting Operating Expenses from the Effective Gross Income (EGI). NOI is the amount left over before accounting for debt service payments. The goal of any income producing asset owner is to maximize NOI because at time of sale, the value of the property will be a direct multiple of NOI. The goal of a value-add strategy is find a cost-effective way to increase NOI, leading to a increase in property valuation.
Capitalization Rate
The Capitalization Rate (“Cap Rate”) is the return you expect to receive from an income stream excluding debt service. Cap rates have an inverse relationship to price. The higher the cap rate, the lower the price and vice versa.
Value-Adds or Value-Plays
The goal of a value-add is to increase the NOI of an asset. This can be accomplished by increase revenue, decreasing expenses or a combination of both. Since value is directly related to NOI, you can substantially increase market value by implementing a sound value-add strategy
For example, if you’re able to increase a property’s NOI by $75,000 and the cap rate is 5%, you can add $1.5 million in value. This is the real power of a value-add strategy, however, the challenge is trying to do the cost-benefit analysis to understand which changes yield the highest value relative to cost of implementation.
7 Common Value-Adds For Multifamily Properties
- Outdated Units
- High Vacancy Rates
- Below Market Rents
- Deferred Maintenance
- Unusually High Expenses
- Lack of Amenties
- Lack of Utility Reimbursement
There are numerous ways to add value but we there are two areas that yield the highest return on investment; individual unit upgrades and adding value to exterior and common areas. Some common unit upgrades are:
- Fresh Paint
- New countertops
- New flooring
- New appliances
- New cabinets
- Upgraded plumbing fixtures
Some common exterior improvements are:
- New signage
- Updated leasing office
- Adding amenities (dog park, pools, clubhouse)
- Fitness center
- Social Gathering areas (BBQ pits, playgrounds, etc)
- Fresh landscaping
Conclusion
The process of finding great commercial real estate properties is equivalent to finding a diamond in the rough. It may look a little tattered on the outside but with a little work and focused effort, you can make it shine. We are big proponents of the value-add strategy and believe that when properly planned and executed, it can deliver significant value for our investors.