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How Value-Add Has Changed Since The Great Recession

WASHINGTON DC 10.19.2017

THE FAIRFAX COUNTY STATE OF THE MARKET

Development Pipeline and Current Projects

Katherine Bonnafé -- Combined Properties
Greg Trimmer -- JBG SMITH
Alex Nyhan -- First Washington Realty

In the 10 years since the Great Recession, the process of value-add multifamily investing — buying a property, renovating it, raising rents, then selling for a profit — has completely changed. Markets with strong population growth and healthy job markets have become the epicenter for the new value-add. 

For sale sign

Putting The Value Back In Value-Add

In the years following the housing crash in 2008, many value-add multifamily assets were in serious need of cash, better management and a new owner. 

“You used to find very low occupancy when we began [in 2011],” Exponential Property Group managing principal Kimberly Radaker said. “We were fixing an occupancy issue as well as getting units to market. By 2013, most properties we were seeing were 90% occupied, but still had a lot of value-add potential as far as amenities, interiors and things that could increase rents.”

When Wehner Multifamily owner Ryan Wehner founded his property and construction management company in 2007, the value of value-add assets was that the new owner had some kind of capital. “Value-add used to mean the previous owner ran out of money and we bought it at a discount, upgraded it just a little and pushed rents about 3% to 5%.”

These days, value-add means a lot more than increasing occupancy. Many value-add firms, like Milestone Group, take a holistic approach. 

“We define value-add not only as interior and exterior renovations but also as potential improvements to management, inefficiencies and capital structure issues,” Milestone co-managing partner Robert Landin said.

That approach may have changed the definition of the term, but realities of financing and finding deals, coupled with the population surge in many Sun Belt cities, have caused a lot of variation in the market. 

Conti Organization CEO and co-founder Carlos Vaz said that benefits renters. Tiers of renovations allow renters to have more options, and more affordability, when choosing an apartment. A tier 1 value-add property may include full renovation of all units, tier 2 may include partial renovation, tier 3 includes some cosmetic upgrades such as new appliances, and tier 4 properties get new paint and some landscaping.

Those upgrades are reflected in rents, with lower tiers allowing for more affordable options in increasingly less affordable markets. 

Knightvest Management
A Knightvest property in Dallas

Today’s Value-Add: More Competition, More Money

The competition for value-add acquisitions has gotten stiff in markets with strong job growth and population surges, like Texas. 

Conti, which has about 15 properties in DFW, is competing with out-of-state and global investors more than ever before. Milestone Group, which has completed more than $10B worth of transactions in the Sun Belt since 2004, is competing for acquisitions more now with private equity investors and institutional groups. 

“The attractiveness of the multifamily sector has only gained momentum over the last 20 years,” Landin said. “That stability [of the sector], tax advantages and residual upsides create more competition.”

Exponential Property Group, which has just under 2,000 units across five properties in Texas, has recently been competing with developers to acquire properties. 

“We see some groups who were doing more building now doing more redeveloping,” Radaker said. 

Many outside investors have seen the success of markets like Dallas, and are now flocking to put their money in Dallas assets, she said.

Financing options have also become more plentiful. 

In 2010, Wehner saw many owners buying a property with a loan and using equity for the rehabilitation. The amount of Fannie Mae and Freddie Mac money, CMBS loans and local bank debt in the market today opens up a lot more options during acquisition and value-add, Wehner said.

Radaker said plentiful financing options might allow more competition in the market, but she thinks the additional loan options have been positive.

“Besides the higher price per door to renovate and lower cap rates, it’s easier to finance now than it was in 2011 [when Exponential was founded],” Radaker said.

Located on Chicago’s North Side, 6110 N. Winthrop is one of seven buildings in a pair of apartment portfolios totaling 329 units recently listed for sale by Chicago-based Kiser Group.
6110 North Winthrop apartment building in Chicago

When Land Value Tops Rental Value

Although it has been the darling of the multifamily world for the last few years, the rising cost of acquisitions and renovations is pushing many owners away from value-add. 

For Vaz, it is simple math. “If you bought 200 units for $10M [earlier in the cycle], you might have spent another $4M in renovations. Now you may pay $16M for that same property, so you can’t put another $4M on top or else the price doesn’t make sense,” Vaz said. If both scenarios allow owners to push rents the same amount, $4M in renovations may only pencil out for the lower price.

Vaz said at some future point the true worth of value-add in attractive infill markets may not lie in the property, but in the land. 

“Value-add will never go away, but at some point the highest and best use of the land will change. Today, buying a 1980s property and renovating it makes sense. In the future, the highest and best use for that land may no longer be multifamily,” he said. 

Landin, Radaker, Vaz and Wehner will be among the participants in the “Value-Add in Class-B and C Apartments” panel at Bisnow's Big South Multifamily event in Dallas on June 28. Register here.

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