Most buyers don't REALLY want value-add investments

[JD Gunter]

When investing in real estate, commercial real estate investors tell me they want to look for a “value-add” investment. A value-add investment is when the property is underperforming in some way and the investor can improve the property in order to improve the value.

In practice, many newer investors don’t really want a value-add investment, or don’t recognize one when they see it. If a commercial property is underperforming, in need of repairs, showing negative cashflow, or has poor bookkeeping records, most self-proclaimed value-add investors will immediately walk away with nothing more than a glance.

Obviously this isn't every value-add investor, I've just seen a trend, especially with newer investors, saying they want value-add and actually expecting turnkey.

From my perspective, a property having obstacles should be expected with a value-add investment. If at least some of these negative circumstances are not present, the property is not a value-add investment.

A value-add investor doesn’t evaluate a commercial real estate investment on where it is, but where it could be.

Negative cashflow, for example, is likely the result of some other underlying issues. Perhaps the owner-occupant is undercharging rents to themselves and the other tenants. Perhaps the property is in bad condition and can't bring in market rents. But simply glancing at the rent rolls, determining that the cashflow is poor and walking away is not value-add investing. 

An experienced value-add commercial real estate investor looks at that situation and sees opportunity, where others only see headaches. An experienced investor will dig into the numbers with a treasure hunter mentality, rather than expecting treasure to be lying around on the beach.

Buying a property that needs little or no repairs, has positive cashflow, organized books, and an excellent marketing presentation is not a value-add investment, it’s a turnkey investment.

There is nothing wrong with turnkey investing, but you can save yourself a lot of frustration by acknowledging that you expect turnkey bookkeeping, condition, location, and cashflow rather than a value-add situation.

To be clear, simply being a value-add property doesn't make it a good investment. Negative cashflow, poor condition, etc, is certainly a problem that needs to be investigated. Sometimes the investigation is worthwhile, sometimes not. You may see how terrible the situation is and decide it's not worth digging.

But if you really want a value-add investment and the property meets at least some of your initial criteria, determining that a property has problems is not the time to walk away, it's the time for true value-add investors to dig in and see if there is opportunity others may have missed. 

You usually won't strike gold when you dig, but you will never strike gold if you never dig below the surface.

[JD Gunter]

Originally posted by @Grant Rothenburger:

@JD Gunter I agree with @Todd Dexheimer, there are a lot of investors that know exactly what it is, but you are right about new investors. I guess that makes sense if they're new to commercial investing, but I would think they'd be up to speed if they had been around real estate for a while.

 I think when some investors think "value-add" they automatically think "rehab." But as you guys know, value can come from a wide variety of sources. A property with poor bookkeeping, poorly used space, or poor marketing can result in an opportunity to bring value and improve cashflow. 

The cashflow numbers on a value-add property will probably look pretty weak on day one. I guess the point I'm making is that investors new to the space should look for a wider range of value opportunities and dig deeper below the surface.