More important: Value-add property or neighborhood growth?

[Max Ball]

When determining a potential real estate investment, which is more important: 

1. Purchasing a value-add property

OR

2. Purchasing a property in an area that is about to grow/gentrify exponentially?

[Ed Matson]

For me, the ability to add value is more important because the ultimate result is more reliable.  If I buy a property in need of work or improvements my after repair/improvement revenues are fairly predictable because they are based on what that market is generating today for a similar property. So, the revenue results are very much in my control.  I just need to execute properly.  If I buy betting the neighborhood will improve, the increase in revenue is totally dependent on outside factors over which I have no control.  This makes it much more risky in my opinion.  A younger person with more of a time horizon and/or a higher risk tolerance might feel quite differently.

[Todd Dexheimer]

I don’t think it’s an either or, but both. 

[Jason D.]

@Max Ball it depends on what your plan with the property is. If you're flipping it, the neighborhood's future isnt as important, so you would probably go with the more immediate payout of the value add. If you plan on holding it, the neighborhood is a more impostant factor, so I'd go neighborhood.

[Omar Khan]

@Max Ball I would like to say both (@Todd Dexheimer) but if I had to pick one, I would purchase a property in an area that is about to grow/gentrify. In non-gentrified markets, rents can only increase up to a marginal amount regardless of the value-add. In heavily gentrifying areas, rent growth can be exponential for many years. This also results in non-renovated units fetching higher rents for years on end. 

In other words, you get to enjoy rising rents without doing any value-add. That's the holy grail!

[Max Ball]

@Omar Khan Thanks for your feedback, Omar! I agree it's the holy grail to get in on a gentrifying area before the trend catches on and ride out the increased rents without technically doing any value-add. How are you currently finding these gentrifying areas?

[Max Ball]

@Ed Matson Thanks for your input, Ed! Agreed that it's much easier to project cash flows via value-add properties and maintain that control you mentioned. I also think that those "outside factors you have no control over" that contribute to a neighborhood improving have been a guessing game, but are actually able to be tracked because of advances in technology over the past couple of years. It's become less risky with a shorter time horizon since AI has really started to come into play.

[Lee Ripma]

@Max Ball In LA you can look at maps to see what’s adjascent to areas that have already gentrified. You can also look for others investing in the area, condo developers, businesses. Koreatown is a great example. In many markets you have to add value since natural market appreciation value is low. In LA, it’s very possible that the market does all the work for you. Just make sure you have the time to wait if you’re counting on the market to do the work for you. But if you get the “free” market appreciation from picking right why not also add value?

[Max Ball]

@Lee Ripma Got it! Appreciate your input, Lee.

Migration areas are key for predicting gentrification. Koreatown is a great example as you mentioned, as well as the Arts District, directly south-east, which became the migration area after Koreatown became overpriced. Now the question is... now that the average price for a condo in the Arts District is $1M+, will the next migration area be Boyle Heights or South of the Arts District 🤔

You are 100% correct, if you're going to get free market appreciation, why wouldn't you add value as well!

[Omar Khan]

Originally posted by @Max Ball:

@Omar Khan Thanks for your feedback, Omar! I agree it's the holy grail to get in on a gentrifying area before the trend catches on and ride out the increased rents without technically doing any value-add. How are you currently finding these gentrifying areas?

Everyone has a theory but it's a total cr*pshoot. We do thorough research but don't bank of gentrification to help us succeed. If it happens, great, if not, meh. The acquisition has to work with or without gentrification. The longer you're in a market, the better feel you develop.  

[Lee Ripma]

@Max Ball I’m thinking both! It’s really only a matter of time. Lots of east side neighborhoods are coming to-Lincoln heights, El Sereno. Spill-over from highland park and eagle rock. In LA you can almost look at a map and see what’s next. Westland is the new affordable alternative to Koreatown, it’ll take a bit, but rents are already on the rise.

[Max Ball]

@Omar Khan It used to be a total cr*pshoot, but with advances in AI over the last couple of years, it's become possible to actually track these indicators of gentrification in real-time. If you look back at how almost every area has gentrified in the past, they all start the same way with 'artists' migrating from an overpriced neighborhood into a new low-income neighborhood, and opening up coffee shops & other millennial-esque stores.

[Max Ball]

@Lee Ripma Totally agree about El Sereno, it's right by USC's medical school and has had a solid increase in activity over the past 4 months, with CBRE purchasing a couple acres right in the center. I went and walked around there a couple months back and there are some very interesting signs of growth.

Boyle Heights has had some issues gentrifying, because anytime people come in and open these new-age millennial shops, the citizens react defiantly, sometimes even violently. The city tends to back these citizens as well. We've noticed that Boyle Heights hasn't had as much growth activity as many people think, and the migration seems to be actually moving south from the Arts District instead of East towards Boyle Heights.

[Gwyeth Smith]

@Max Ball I will echo the "both" replies here but to answer your question as which one is more important for me, I say value-add.  The value-add model allows us control in either increasing revenues or streamlining expenses.  I personally would not invest in an emerging market if there were no value add component to the deal.  However, I would invest in a mature market if there was enough value to be added.

[Marjeanne Fields]

Economy of the area is the very first thing that is important to me. If that looks good then I start to look at the value add opportunity. In my opinion- its not one or the other... its both!

[Max Ball]

@Gwyeth Smith Gotcha. I agree that for value-add properties you've always had more control by being able to predict increased revenues & streamlined expenses. Emerging markets have been harder to quantify in terms of % appreciation gains in the future. I'm curious, if there was a way to accurately predict that appreciation in an emerging market YOY, would you consider purchasing property with no value add component?

[Max Ball]

@Marjeanne Fields Likewise, Marjeanne! I always look at the economy of the area first THEN dive into what value add opportunities exist in those areas.

[Marjeanne Fields]

@Max Ball Awesome! 

[Omar Khan]

Originally posted by @Max Ball:

@Omar Khan It used to be a total cr*pshoot, but with advances in AI over the last couple of years, it's become possible to actually track these indicators of gentrification in real-time. If you look back at how almost every area has gentrified in the past, they all start the same way with 'artists' migrating from an overpriced neighborhood into a new low-income neighborhood, and opening up coffee shops & other millennial-esque stores.

It sounds nice in theory and I'm a big fan of tech, but currently RE tech is 2-3 decades behind the curve. Unless you have a model which can 100% predict where the next hot spot is going to be (and you might have, in which case we should become best friends), it will remain, at best, a guess - albeit one "backed" by more math than I would understand.  

[Theo Hicks]

It's a combination of both plus (and most importantly), you and your team's ability to execute the value-add business plan. The best deal in the best market means nothing if you cannot execute the business plan.

[John Hickey]

@Omar Khan between total crapshoot and predict 100% there is a lot of room to operate in.

[Moises B.]

@Max Ball the former.  The time and energy that goes into r/e investing makes it difficult for at least me to go gambling.  I tend to analyze deals with a value add mentality (within reason of course), if the latter happens it's a bonus.  These are strange times in r/e and interesting.  With that said, keep striking.