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SHOW NOTES FOR EPISODE 288: WILL VALUE-ADD INVESTING WORK IN 2021?
Value-add is probably a familiar term to many real estate investors. It has been the primary strategy for investors purchasing apartment buildings for many years. However, this investment strategy was significantly jolted by pandemic-related shutdowns. In this podcast, Bill examines the strategy and whether or not it can still work in a post Covid economy.
Tip of the Week
Tenant Retention Tip: Punishing Bad Tenants Without Rewarding Good Ones
Bad tenants seem to be most of your attention, but it is the wise landlord who recognizes the good tenants with something of value for being good. If you are already a landlord or will be in the future, sooner or later you will receive a call from another landlord verifying the background on one of your good tenants.
The entire time that tenant was with you, the rent was always paid on time the apartment was always kept needing clean and not a complaint was heard. As a matter of fact, you forgot they even existed.
That’s why they’re moving.
Give your good tenants simple rewards to show them you appreciate them. Here are some inexpensive ways to show good tenants that you care for anyone who has paid rent on time for the entire year, consider giving them a turkey for Thanksgiving. Or maybe paint a room, or give them new carpet in one of their rooms.
The cost of turning over a unit is much greater than any of the three things I just mentioned. Be creative when rewarding your tenants. Why not give a good tenant an ice cream cone certificate in the summertime, or any other type of gift card, especially to a restaurant that they may like in the area?
Your tenants will like and respect you and your turnover rate will be lower
Will Value-Add Investing Work in 2021?
Value-add is probably a familiar term to many readers, but not all. I promise it will make intuitive sense in a moment.
The simplest way I can quickly explain the value-add opportunity is buying an asset that has a known return on investment (ROI) and meaningfully improving some aspect of the property in a way that the ROI on the improvements is much higher than the ROI on the asset as a whole. In other words, meaningfully raising the average ROI on the entire project – which means increase the value.
Value-add multifamily projects can entail a wide range of business plans depending on the target tenant, building size, and investor’s competencies. Experienced value-add investors also closely consier how much renovation risk they are willing to accept and how much they can feasibly spend per unit.
I am a value-add investor and generally, you find a property, hopefully at a discount, often bring in new management, upgrade the individual units, do some exterior upgrades, generally paint, maybe do some landscaping, maybe add amenities like a dog park, bike stations, or outdoor barbeque picnic areas. Increase rents, reduce expenses and then sell in 3-5 years. Investors get nice dividends and a big bonus when it sells.
Note that the value-add play is not the only way to profitably invest in commercial multifamily units. One could also invest in new development, stabilized properties, momentum plays, or other opportunities and do very well.
However, this investment strategy was significantly jolted by pandemic-related shutdowns. So, how strong is the segment now?
The practice of purchasing an underperforming multifamily asset at a discount, implementing significant renovations and raising rental prices, has grown in popularity over the last several years. But like much else in the multifamily industry, value-add investment suddenly became the subject of uncertainty when COVID-19 took hold in early 2020.
Value-add apartment sales totaled $32 billion in transaction volume in 2018—16 percent of all multifamily deals—according to Real Capital Analytics. But the unpredictability of the pandemic caused many investors to pull back or put deals on pause, and to reexamine their business strategies. The second quarter represented the lowest multifamily investment sales for any quarter in almost a decade.
With the end of the year in sight, multifamily investment activity overall appears to be back on track. During the third quarter, sales totaled $24 billion, a 55.9 percent increase from the previous quarter. Still, conditions are making buyers more careful in how and where they are choosing to make deals.
In a recent article by Multi-Housing News, experts from major brokerage firms and value-add investment firms were surveyed about how things have changed since March, how the value-add market now compares to last year, and the markets attracting the most deals at the moment.
After a Pause, Back to Business
Jeanette Rice, real estate economist and head of multifamily research at CBRE, noted that activity in the value-add segment never completely stopped during the global health crisis. She’s seen closings rise since July and expects the most recent numbers to be even higher. However, in the early days of the pandemic, there were moments of uncertainty among investors.
“Early on we did see value-add buyers really sort of pause, because we weren’t sure what would happen with rents,” said Rice. While the buyers have returned, activity isn’t quite back to the level it was before COVID-19. And large gateway cities are feeling the pain more than other areas, with Washington, D.C., Los Angeles, Seattle and especially San Francisco and New York City underperforming.
Colliers International Vice President Kalah Espinoza recently closed a $65 million sale in Reno, Nev., that was the metro’s largest value-add transaction in more than a decade. The property—a 300-unit apartment community in West Reno—was first brought to market in 2019, and, Espinoza reports, generated “tons” of interest. Despite concern over the pandemic, the deal got done.
While Espinoza says investors and owners of value-add properties have stretched out their timelines and are pulling back on renovation spending, Espinoza’s markets—Northern California and Northern Nevada—have performed well over the last several months.
“Investors are looking a lot more at secondary and tertiary markets right now, where there’s a lower cost of living but still an attractive job market,” said Espinoza.
In response to changing conditions, Prism Multifamily Group tweaked its value-add strategy for Las Vegas. Before the pandemic, the firm was in the midst of upgrading its B/B-minus portfolio in the market to the B-plus level. Occupancy was high, as was demand for renovated units. But renters have become price-sensitive and aren’t looking to spend more for upgraded units. “We were doing really well in our value-add execution,” said Mark Zolty, president & founder of the Toronto-based investor, which operates in markets across the U.S.
His firm chose to hold back on more renovations in Las Vegas for the time being and pushed back new upgrades in the metro by 12 to 18 months. “This market is really hurting as far as income is concerned, so we might as well have a product that meets what the customer is looking for,” said Zolty.
Meanwhile, the COVID-19 pandemic has had little impact on Prism’s upgrade program in South Florida, where the firm is still seeing ample demand and actively pursuing projects. “We stopped in April, we weren’t sure which way the market was going,” he said. “By June we realized we had strong demand, so we might as well continue renovating.”
Getting Back On-Track
After an initial pause, deals are flowing again, and investors are looking for opportunities. Metros getting the most attention now already had strong fundamentals before COVID-19 and have been less impacted than other areas. With low cost of capital and greater stability in the market, investors will look to implement value-add renovation plans sooner rather than later, said Tai Cohen, a senior director in the Sunbelt multifamily advisory group at Cushman & Wakefield.
“There was a small pause in April where people were holding off, but it feels like that has changed, and people are doing value-add as quick as possible,” said Cohen.
In his market, which includes metro Charleston, S.C., the first quarter of 2020 was the biggest ever for his team, followed by an “extremely slow” second quarter and a “very active” third quarter. “Right now, we’re probably as active as or more active than last year,” said Cohen, adding that the potential of capital gains changing post-election, historically cheap debt, liquidity and the popularity of the Sun Belt are the drivers of the activity.
Espinoza’s markets include the booming Reno-Sparks region, which has proven to be an attractive alternative for renters looking for good jobs and a lower cost of living than in Silicon Valley. However, the markets with the most draw have been those where rents are climbing. “Value-add is really popular when there’s pressure on upward rents on a market, and right now rents in Reno and Northern California are either staying flat, or in some places declining,” she said.
Instead, markets where population growth is exerting upward pressure on rents, like Boise, Idaho; Austin, Texas; and Raleigh-Durham, N.C., are still proving to be the most popular with investors. Topaz Capital Group, which invests in value-add properties in Southeastern markets, is continuing its value-add plans, though with some adjustments. The firm will implement upgrades over longer periods, increase the minimum occupancy threshold, and focus on exterior renovations while monitoring leasing traffic.
“There’s a lot more studying we’re doing now as opposed to the past, when we were more confident, needed less studying and meticulous analysis,” said Topaz’s Managing Partner & CEO Marc Hershberg. “We’re definitely combing over how units are being absorbed in the marketplace.”
Pent-Up Demand
There’s no way of knowing when the pandemic will subside and how the multifamily market will be affected next year by the economic downturn, widespread loss of jobs, eviction moratoriums and rent collection struggles. That said, industry veterans expect the market to perform well in 2021.
“I think there’s a lot of pent-up demand, which is part of the reason the multifamily market is so active right now,” said Cohen. “So many people sat on the sidelines in Q3 and Q4 (last year). I think Q4 of this year will be more active than last year and I think we’ll see historic numbers all through next year.”
The prospect of another major lockdown during the winter months is something that could potentially have a huge impact on the multifamily market and in turn the value-add segment, said Espinoza of Colliers International. Class A and Class B properties would stay relatively resilient, but properties with a high proportion of residents employed by hotels, casinos and restaurants could take a significant hit.
Another factor is the cost of construction, which has been on the rise for some time. That has been the case for at least five years in the Northern California and Reno, Nev., regions where Espinoza’s work is focused.
“The last conversations I’ve had with developers, they’re pulling back from developing, stopping, maybe waiting it out,” she said. “Other developers are saying they’re actually seeing signs that maybe construction costs will trail downward. But I’d say right now they’re still incredibly high, so many developers are shovels down, just kind of waiting it out to see what happens.”
Taken from an article in Multi-Housing News
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