Intro to Value-Add
Whether you’re looking to invest in Class B or Class C multifamily properties, a good value-add strategy can deliver a substantial return for your investment if done the right way. How long you choose to hold on to those properties, what markets you target, the quality of management, and the level of renovations will all play roles in how much return you can expect from the property. With multifamily new construction overwhelming certain markets, value-add (investing in and raising the value of older, lower-valued property) can be a way of entering the multifamily market with less risk and more reward.
A Class C property will take more resources to upgrade to Class A status than a Class B but, depending on other circumstances, the C property could still be worth it. You should consider obvious factors like the property’s location, reputation, and historical revenue stream. You will likely investigate other potentially market-shifting trends that could result in a boom or drop-offs in value such as the migration of the massive millennial and baby boomer demographics or the amount of new property construction.
The approach is multifaceted but the fundamental basics remain the same.
No matter which market you choose, property valuation will always be at the forefront of the investment discussion. If you are new to multifamily investing, you should be aware of how properties are classified if you aren’t already. The majority of the pertinent investment factors are included in the rating system: location, tenant income, income from rent, and current amenities.
Class A properties will generally be the most modern and well-located, attracting higher-income tenants with highly professional management. Maintenance requirements will be lower and energy efficiency will be excellent (relatively speaking) while rental income remains high. Achieving this classification from that of a B or C level property, and preferably maintaining it, is the goal of value-add.
Class B properties are the primary targets of value-add investing and for good reason. These properties possess less risk than Class C properties and will need less upfront investment to upgrade to an A classification (or B+). The CAP Rate will be higher for these properties than A properties.
Class C properties possess the most risk and might be pigeonholed in poor locations. They are generally much older than their A and B counterparts, requiring much higher upfront renovation costs, while rental income is substantially lower.
The amount of time you plan to hold a property entirely depends on your risk evaluation. A short-term hold will grant you more flexibility and allow you a much faster turn around time to refinance. A long-hold strategy could involve taking out a 7+ year loan, but at generally lower interest rates without as many upfront costs.
Your plan of action for hold times will derive from your research on the cost of potential renovations and the overall turnaround. You need to compare your target property to other properties within the same market and classification. Once you have an idea of whether your goals of turning around a property in less than three years is realistic (at an affordable cost), you can consider whether or not a shorter-term loan would be worth taking.
Beyond having a general knowledge of property classifications, keeping current on rising and falling markets is going to be the obvious next step in determining where and how to invest. Some markets are likely to stay consistently desirable (Dallas, LA, New York), while other markets will rebound in a big way (Phoenix, Las Vegas) from rougher economic pasts. Rising markets, like Phoenix and Las Vegas, will often see major boosts in new construction which will mean higher levels of competition. Some markets, like Las Vegas, will have substantially reduced their construction after a recent windfall. Be sure to thoroughly evaluate current and future competition before diving head first into a value-add investment.