The two key components of the value-add strategy in multifamily investing

Recently, we covered why you may want to consider multifamily for your next investment and the kinds of opportunities available in that sector. That was a start, but there is always more to learn! If you are interested in beginning multifamily investing, you probably want to learn more about the specifics of how operating a multifamily investment property works. When it comes to multifamily investing, the “value-add strategy” is one of the major keys to growing your property’s value and your returns.

To help explain how the strategy works, we once again spoke with Seth Ferguson, Chair of The Multifamily Conference and an investor with over 13 years of real estate experience. Through his podcast, cable TV show, and investor conferences, he aims to share the many opportunities and benefits of investing in multifamily properties.

The important foundation for understanding the value-add strategy is that commercial properties are not valued in the same way as residential real estate. Rather, commercial property valuation relies on an income-based approach, meaning the value of the property depends on how much money it produces. By increasing your net operating income through the value-add strategy, you can not only increase your cash flow but also improve the overall value of your asset.

The net operating income (NOI) of your property is calculated by subtracting operating expenses from the gross income. Not included in this calculation are capital expenditures and any debt service expenses. A property’s overall value can be determined by dividing your NOI by the market capitalization rate. The result is that, with a favourable market cap, every dollar you add to your NOI can increase your property’s value by much more.

“The value-add strategy entails acquiring an underperforming asset and improving it to increase the rent it produces, which in turn increases the value of the property,” explained Ferguson.

“There are two components to that. One is physical improvement and the other is operational improvement.”

Physical improvements include anything relating to the property itself such as the structure, fixtures, finishes, amenities and more. For example, by replacing old flooring or redoing the kitchen in a rental, you can provide tenants with a higher quality property that they will be willing to pay a higher rent for. Beyond the units themselves, improving communal amenities like gyms, pools, and parking lots, as well as improvements to the exterior of the property can all contribute to adding value.

Operational improvements include aspects of how you run the business that is your property.

“The most basic operational improvement, if you’re acquiring a property with under market rents, is to raise the rents,” said Ferguson. “You can also change the staffing on the property to give the tenants a better experience. You can optimize your expenses by reducing utility usage through eco-friendly faucets and toilets. You can change the branding of the property, such as changing the name and the feel of the property. You can change your advertising strategy. There are so many different ways to improve on the operational side.”

Of course, in order for the value add strategy to work, you need to identify properties that are underperforming, meaning you should aim to identify opportunities to employ the value-add strategy as early as the buying stage. 

Keep in mind that buying an underperforming property doesn’t just mean buying a property that is as cheap as possible and falling apart. Instead, you should look for properties with great potential but that are not doing as well as they could. There can be physical issues like dated interiors or operational issues like mismanagement.

“You’re looking for properties where you can implement the value-add strategy to bring them up to market standard and bridge that gap from where the property is today and where it could be tomorrow,” explained Ferguson.

Another key to employing a value-add strategy is to understand the market that your property exists within. There is such a thing as improving too far to the point where the building no longer fits the needs of tenants in the area. When looking to add value to your property, you should try to compare it with similar nearby properties that are performing well.

“What over-improvement means can depend on the specific market and the property type, but you certainly don’t want to over-improve a property. It’s really important to understand the market and what tenants are looking for. You always want to find comparable properties in the area as a gauge of what is working. Look for tested and proven solutions so you can actually gauge how much of a rent premium you can realistically achieve. You have to really understand the market before you even start doing any work.”

In terms of the first things an investor should look at when employing the value-add strategy, Ferguson pointed out a few simple things that can make a big difference.

“Number one, you can raise the rents – that is the simplest one and the least costly move you can make. Then you can start looking at interior renovations like improving kitchens and bathrooms. Another one is the branding of the property. What kind of tenant are you looking to attract? That’s also going to depend a lot on the branding and how you present the property. Then you may want to look at your staff. For instance, if you have a leasing manager who’s not converting prospective tenants at a high enough rate, you may consider making a staffing change. You can optimize your expenses because a leasing manager with a higher success rate will be converting more prospective tenants into paying tenants. Your advertising budget can be reduced because you’re becoming more efficient. It’s all about efficiency here because any efficiently run property is a profitable property.”

Overall, the value-add strategy is a powerful way to increase your cash flow and the value of your asset in a single process. For many multifamily investors, the value-add strategy is key as the value growth of the property can greatly outweigh the amount of money and effort you put in to employ the strategy.

Hopefully, you now have a pretty good idea of how you can make money in multifamily investing by employing the value-add strategy. For investors who are serious about growing wealth in multifamily investing and want to learn even more, consider attending the upcoming Multifamily Conference, hosted May 14-15 in Toronto. This in-person conference brings together some of the biggest names in the field and provides unmatched opportunities for learning, growth, and networking. Visit The Multifamily Conference to register now.

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