Value Added Transactions Mastery Lesson 07

Lesson Seven: Adding Value to the Property & Different Asset Classes

When the investor acquires a value added property, improvements are usually needed. However, the investor must determine if the improvements will add value (increase NOI) or are simply required for normal maintenance.

7.1 Improvements and the Budget

Every value added deal has a budget to improve the property. The best investors get the biggest “bang for the buck” on the improvement budget. The best investors bring the improvements in on time and on budget. The best investors also differentiate between improvements that are required to maintain the property and do not add value, and those improvements that do add value.

One of the rules to consider is what tenants expect. Tenant do not pay for new roofs or new HVAC. They assume that these items are in good working condition. These are considered deferred maintenance from the previous owner that needs to be addressed.

Value enhancing improvements that will provide increase rent and occupancy and add value to the building include the following:

  • New façade
  • New parking lot surface or re-striping to add additional parking spaces
  • New landscaping
  • Interior work (e.g., bathrooms and kitchen)
  • Project amenities

One major key item in any value added or repositioning strategy is to understand how the capital improvements will increase the NOI. The investor should look at the following variable: initial NOI vs. stabilized NOI. The delta of these two numbers should be examined carefully, and the value added improvements should be able to achieve the delta.

7.2 Adding Value to Different Classes

The key to any repositioning strategy is to understand how the property improvements will affect the future NOI. Most transactions will have component of each, and the multifamily rehab lender must understand.

Multifamily

Multifamily rehabilitation (rehab) can generally be divided into the following categories:

  • Minor: Paint, landscaping, parking surface, and so on
  • Moderate: New kitchens, bath, carpet, and other interior improvements
  • Major: Total “gutting” of units and updating the entire interior; could include updating HVAC systems

The investor must consider the potential for project rehab to interrupt current occupancy and to cause a decline in cash flow over the rehab period. For example, will the tenants say in their units (rolling rehab), or will the tenants be displaced from the units while being renovated? The investor should look carefully at going-in net operating income (NOI), compared to post-rehab NOI.

Retail Properties

Retail rehab can generally be divided into the following categories:

  • Minor: Face lift to center, new/repaved parking lot, and new signage
  • Moderate: New center façade, re-arranging the physical spaces
  • Major: De-malling centers (e.g., eliminating shop space with junior anchor tenants), building out parking-lot pad space, and additional construction.
Office and Industrial Properties

This type of rehab can generally be divided into the following categories:

  • Minor: Improved general appearance, new parking lot, renovation of common areas
  • Moderate: Increased efficiency, new electrical or HVAC system, redesign of floor layouts
  • Major: Total gutting of property, taking the property down to concrete and rebuilding from the inside out, including the new systems and new interiors

When deciding on any improvements, it is important to look at how the new rents will compare to the current market rents. There are two questions you should consider:

  1. Are the projected rent in line with the current market, or is the project trying to push or lead the market rents into new highs?
  2. It is best when the exit strategy works with rents and occupancy underwritten to current market conditions. If not, the investor must be cognizant of the “market bet” they are taking!

Assignment:

When the investor acquires a value added property, improvements are usually needed. However, the investor must determine if the improvements will add value (increase NOI) or are simply required for normal maintenance. What are the key components of the budget? What are the top ways to determine the most “appropriate” budget?

This assignment is your study guide to ensure you have learned these materials before you take the required quiz.


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