3 Benefits of Value-Add Multifamily Investing

By Ketan Patel
Date July 7, 2021

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3 Benefits of Value-Add Multifamily Investing

With so many investors drawn to multifamily investing, competition for properties is higher than ever. Class A multifamily tends to attract the most interest from institutional buyers given that it is expensive but relatively low-risk. Class A properties, given their low-risk profile, tend to provide lower returns. Investors seeking more value are increasingly drawn to Class B and Class C value-add opportunities, where risk is somewhat higher but accordingly, the returns are higher as well.

Value-add multifamily investing, particularly deals in the $5- to $30-million range, is a strong alternative to those priced out of Class A opportunities. As the number of renting households continues to climb, real estate investors are seeing value-add deals as a way of capitalizing on the socioeconomic shift from home ownership to renting.

In this post, we’ll explore three advantages that value-add multifamily investing offers.

What is Value-Add Real Estate Investing?

Value-add real estate investing is when someone buys an underperforming asset and then makes strategic improvements to improve cash flow and enhance the property value. Value-add multifamily investing is an increasingly popular strategy, particularly as construction of new apartment buildings has become more expensive; in some markets, the numbers just don’t support building new construction anymore as labor and material costs have skyrocketed. An alternative is to buy older, outdated multifamily properties that can be improved — an investment strategy that can be highly lucrative when executed properly.

Typically, value-add multifamily deals are those that need some combination of either light or heavy renovations. This could include the renovation of units and/or the addition of property amenities. Value-add multifamily investing also seeks to improve cash flow through operational improvements or other reductions in expense. As net operating income increases (NOI), so does the property value.

As noted above, value-add multifamily investing is considered somewhat riskier than buying an already stabilized asset, but investors can expect higher returns to coincide with the higher risk. The increased risk is due to the many unknowns that value-add investors face. Investors are essentially taking a gamble that: a) they will be able to afford the renovations necessary; b) that the renovations will result in higher rents; and c) the increased rents can be sustained over the long-term. Given the risk profile associated with value-add multifamily investing, passive investors generally expect to earn a higher return.

There are different levels of value-add investments. Some sponsors will pursue a “light” value-add strategy in which returns would be more heavily distributed to income rather than appreciation. A “heavy” or “deep” value-add play will usually require more substantial renovation but in exchange, should result in both increased cash flow and significant appreciation.

Advantages of Value-Add Multifamily Investing

There are many advantages of value-add multifamily investing, including the three featured here today.

• • • Lower Barriers to Entry
      One of the key draws of value-add multifamily investing is that it is more accessible to the masses. Few people have the capital necessary to invest in costly, stabilized assets such as a luxury apartment building located in a major metro area. Value-add multifamily comes in all shapes and sizes, ranging from 2- to 4-unit multifamily investments to 300+ unit apartment complexes. Depending on an investor’s budget and access to capital, investing in multifamily properties using a value-add strategy can be more accessible, especially when first getting started. (Conversely, it can be harder to successfully execute a value-add strategy, so this is something investors should bear in mind. When in doubt, invest in syndication real estate with a sponsor who has experience with value-add multifamily deals.)

• • • Less Capital Intensive
      This might seem counterintuitive. On one hand, significant capital is typically needed to improve value-add properties. On the other hand, there is less up-front capital needed compared to purchasing a more expensive, stabilized asset. Someone who invests in a value-add property can make improvements at their own pace and over time, spreading out capital costs versus investing a huge tranche of money up front. This lowers the barrier to entry for investors looking to purchase value-add real estate.
      Another thing to consider is that value-add multifamily investing can take many forms. A value-add “light” strategy might simply require new paint, flooring and fixtures in each unit. More extensive renovations might involve the complete gutting and renovation of each unit – but this might not be necessary, depending on the investor’s value-add business strategy.
      In syndication real estate, some sponsors will find inexpensive operational tweaks that dramatically improve cash flow. For example, replacing an ineffective property manager with someone new might result in lower vacancy rates and improved rent collection. The simple introduction of a tenant software program can help streamline operations and lower costs, a change that does not cost a lot to implement.

• • • Ability to Earn Higher Returns
      As noted above, value-add multifamily real estate tends to be considered riskier than investing in an already stabilized, cash flowing asset. Generally, value-add investors are willing to take on more risk to achieve higher returns. Annual cash flow from operations might be in the 7-11% range compared to investing in a stabilized, institutional asset  in which returns might be closer to 4-8%. There is a potential of additional return upon disposition or refinance of the asset when the value-add plan is completed.

Those who successfully execute their value-add multifamily real estate strategy will find themselves with several options upon stabilization. Lenders are usually happy to refinance stabilized properties with attractive terms on multifamily loans. If an investor is not interested in refinancing the property, and instead, would rather sell, they will find a deep pool of buyers eager to add stabilized multifamily assets to their portfolios.

Value-add multifamily investing is not for everyone, particularly those who are highly risk-averse, but it can be highly lucrative for those willing to take on the risk. A great way to get started with value-add multifamily investing is to invest in syndication real estate alongside a sponsor who is adept at executing value-add strategies.

Are you interested in learning more about value-add multifamily investing? Contact us today. We have several value-add deals in our pipeline and would be happy to discuss our approach with you in more detail.