You’re probably familiar with the typical fix-and-flip residential real estate profit model because it’s all over HGTV, and I, too, can’t get enough of the excitement. Each episode ends with me wondering what kind of crazy issues and incredible renovations on which beat-down real estate property they’ll tackle next!
In the case of single-family homes, investors often buy a run-down property, gut and remodel the outdated features, infuse it with style and beautiful fixtures, and then sell it for a sweet profit. If you were the flipper, you poured in your talents, time, and sweat equity, in exchange for profit from your investment.
This is essentially a value-add deal for a residential property. Now take this concept and apply it on a much larger scale, like multifamily real estate. Hundreds of units get renovated over years at a time instead of just one single-family home over a few months.
What Is A Value Add Real Estate Syndication?
The value-add commercial real estate syndication model is nearly identical to a residential fix and flip, but it’s applied to commercial real estate properties such as office buildings, retail space, multifamily properties, warehouses, hotels, and so on.
In value-add real estate situations, you’re still buying a distressed property – although this time, it’s already being used as rental real estate and is at least partially occupied.
A group of investors (including you as a passive investor in the real estate syndication) and the sponsor team combine efforts to purchase, add value to the property, then turn around and sell it at a justifiably higher market price. You’re adding value to the property by making renovations that increase the functionality, features, and allure of the investment real estate before selling it.
Excellent opportunities for value-add real estate syndication deals include commercial properties with peeling paint, old appliances, or overgrown landscaping that detract from the curb appeal. Simple, cosmetic improvements can attract tenants willing to pay higher rental rates and increase property revenue.
In value-add properties, real estate improvements have two goals:
- Improve the property inside and out (positively impacting tenants)
- Increase the bottom line (favorably affecting investors)
What Improvements Can Be Made To Value-Add Real Estate Syndications?
As far as value-add real estate syndications go, the sky’s the limit on what can be done to improve real estate syndication properties. There are a few different value-add strategies, but they’re about making improvements that will solve the biggest problems of the property or make it more attractive for potential tenants and buyers. Other forced appreciation strategies might include:
- Fresh paint
- New cabinets
- New countertops
- New appliances
- New flooring
- Upgraded fixtures
In addition, sprucing up the exterior and common areas of the property might help build a sense of community pride:
- Fresh paint on building exteriors
- New signage
- Dog parks
- Covered parking
- Shared spaces (BBQ pit, picnic area, etc.)
Furthermore, increasing the overall efficiency of the property can add value:
- Green initiatives to decrease utility costs
- Shared cable and internet
- Reducing expenses
- New property management team
How Value-Add Multifamily Improvements Are Completed At An Occupied Property
The single-family home fix-and-flip is something most people are familiar with, but when it comes to hundreds of units at once, the process and logistics aren’t as straightforward. You’re probably wondering how the sponsor team can efficiently renovate an entire multifamily complex while people are living there.
Vacant units get renovated first in a value-add multifamily real estate syndication business plan. For example, a 5% vacancy rate in a 100-unit complex indicates there are five vacant units, and that’s where renovations begin.
When those five apartments are finished and each existing tenant’s lease comes up for renewal, tenants are given a chance to move into a newly renovated unit. Tenants usually appreciate the larger room and are glad to pay a little more if necessary.
When tenants leave their old apartments, renovations begin on those vacant units, and the cycle repeats until most or all of the units have been renovated. Then, slowly, as more renters move into the newly renovated units, the overall rental income of the property increases, contributing to the rise in cash flow distributions for investors.
In some cases, tenants do move away during the renovation process, and it’s critical to anticipate a temporary rise in vacancy rates due to turnover and new leases.
The Benefits To Investing In Value-Add Multifamily Real Estate Syndications
Value-add real estate syndication methods, when done well, benefit everyone involved. For example, we provide tenants with a more aesthetically attractive property by upgrading their appliances and enhancing the shared community spaces. As a result, the property becomes more valuable, allowing for higher rental rates and faster equity accrual, which makes investors happy as well.
The process of improving real estate and the fact that refurbished property is more appealing to tenants are most likely self-explanatory. First, however, let’s look at why value-add investing is such a good idea for real estate syndication investors.
Non-Value-Add Real Estate: Hoping For Appreciation Without Adding Value
We must first understand yield plays before we can fully appreciate value-add commercial real estate investments. In a yield play, investors buy a stabilized real estate asset, do not conduct value-add renovations, and retain the investment property over an extended hold period for monthly cash flow with the expectation that the real estate market will appreciate and yield profits at the sale.
Yield plays are real estate investments that seek to capitalize on the income potential of a real estate property that is currently cash-flowing. The yield comes from the recurring rents collected. It’s assumed that the sponsors will sell it later for a small profit, but there is no business plan to renovate, force appreciation, or enhance the asset to achieve a greater return at the sale.
Yield play investors invest in real estate with the belief that it will appreciate due to future real estate market increases. Still, there’s always the possibility of a flat or declining market.
How Commercial Value-Add Real Estate Syndications Work
As value-add commercial real estate investors, we buy real estate properties with a value-add advantage and commit our expertise to dramatically improve the property with value-adding renovations.
In a value-add commercial real estate investment, significant work (i.e., renovations) is required to boost the property’s value, and such improvements come with a degree of risk.
However, value-add real estate syndications come with a significant potential upside because the investors have complete control. Value-add real estate syndication investors don’t simply wait for the market to rise. Instead, they use physical action steps to improve the property and boost its market value, forcing price increases through bettering it, raising rents, and lowering expenses.
Property improvements boost commercial real estate income; therefore, equity in the transaction increases (keep in mind that commercial properties are valued based on how much revenue they produce, not on comparable sales, like single-family homes), giving commercial real estate investors far more control over their investment than in a yield play.
Of course, a combination of income and value-add investments is ideal. This is where a real estate asset’s quality is improved, cash flow distributions are pressed upward, and the real estate market grows simultaneously. In these cases, real estate syndication investors have complete control over the value-add refurbishment process while the market simultaneously increases, creating excess equity for investors.
Now, before you go crazy about the possibility of a hybrid investment, keep in mind that there are risks with every deal.
Examples of Risk in Value-Add Real Estate Investments
In a multifamily value-add real estate syndication, 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)
Risk Mitigation In Value-Add Real Estate Syndication Investments
As you explore the possibility of investing in your first or next real estate syndication deal, look for sponsors who prioritize capital preservation and have a variety of risk mitigation tactics in place. Some excellent ways to mitigate risk 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
It’s easy to get caught up in the idea that value-added real estate investments are always a good thing. But, in reality, they come with their own set of dangers. This is why risk management practices are so vital – to defend investor money at all costs.
Why We Prefer Value-Add Deals Over Other Real Estate Syndication Opportunities
The phrase “no risk, no gain” may be applied to any type of financial investment. However, it becomes desirable when something, despite its dangers, delivers significant advantages to the community AND investors.
Properly utilizing investor money in value-add multifamily real estate investments produce significant improvements to apartment complexes, resulting in cleaner, safer homes for tenants. In addition, these renovations improve the property’s value, raising rents and making a significant difference. Meanwhile, increased cash returns compensate investors for taking on risks associated with commercial real estate while minimizing operating expenses.
Unlike many opportunities that can only be accessed through a bank or financial advisor (or some other type of intermediary), value-added syndications can be initiated directly with sponsors – all it takes is at least $50,000 in preferred equity and a few hours of your time to evaluate the value and feasibility of a real estate syndication investment opportunity.
Commercial real estate syndications are not limited to apartment complexes, mobile home parks, or even parking facilities. They are available for retail properties, office buildings, mixed-use spaces – you name it! The value that can be added to practically any type of property makes value-add real estate investing attractive to novices and experienced investors alike.