Good article in Asset Management Quarterly Value Add Has Its Day talking about how investors have split since the Financial Meltdown in 2007 into a risk adverse group favoring mostly Class A apartment building investments in core markets and a more risk tolerant group seeking high returns by purchasing distressed debt.
This has created an opportunity to generate good returns with investments in properties that need help of some kind. A few bullet points:
- “It’s [The polarization] left this big open hole in the middle of the playing field for middle-risk, middle-return strategies, and it’s made the pricing on value add very attractive,”
- “It should be an extremely desirable place to invest but you haven’t seen a lot of investors go there yet, which is why it’s such an interesting opportunity.”
- buyers needn’t take on excessively risky scenarios in order to reap a handsome return of 11-15% over the medium term
- “You can put on less financing and take a less involved program risk and get the returns you could five years ago with higher risk,”
- Multifamily projects with room to add value, then, may be those with good locations and a few correctable problems. That enables an investor to acquire the asset for a lower price then upgrade to bring its income stream in line with those of core properties
- “This strategy allows an investor to own a property at below replacement cost and, to the extent the repositioning strategy is well executed, realize an income stream at a yield that is a premium to core properties today,”
A good location is still key but finding a property with ‘the right things wrong with it,’ especially one with a distressed owner will provide good returns for the savvy apartment building investor.
What is ‘Value Add’? From The Real Estate Research Corporation www.rerc.com:
A value-add investment implies that an investor adds to the value of the property by pursuing an upgrading strategy. This could include a modest level of physical property upgrading (i.e., a Class B property upgraded to Class A), taking moderate lease-up risk on an unstabilized property, or buying a property with contract rents below market.
RERC had a nice graphic in one of their papers from a few years ago that shows the spectrum of real estate investment:
This matrix is geared more towards institutional investors but it explains the relationships between the terms commonly used around real estate investment.