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Updated over 5 years ago, 05/15/2019
Most buyers don't REALLY want value-add investments
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.
Interesting. Thanks for posting.
Originally posted by @Jeff Morelock:
Interesting. Thanks for posting.
I'm glad! Thanks for commenting
JD, that’s an interesting observation about new investors who may talk about the benefits of a value add, but mostly walk away from them. I have done one value add in 2012 and another in 2018. Currently, I’m working on only my third value add. This one is a little scary since I’m doing somethings I’ve never done before. So I can understand a new investors disinclination. Yes, you can do your due diligence and mitigate much of the risk, but until you’ve done a few, it’s difficult to overcome the fears. And this fear can be good. It forces you to be more cautious and work through the what ifs. You just need to be able to accept that you can’t know everything and will have to ask some risk.
Originally posted by @Bryan Mitchell:
JD, that’s an interesting observation about new investors who may talk about the benefits of a value add, but mostly walk away from them. I have done one value add in 2012 and another in 2018. Currently, I’m working on only my third value add. This one is a little scary since I’m doing somethings I’ve never done before. So I can understand a new investors disinclination. Yes, you can do your due diligence and mitigate much of the risk, but until you’ve done a few, it’s difficult to overcome the fears. And this fear can be good. It forces you to be more cautious and work through the what ifs. You just need to be able to accept that you can’t know everything and will have to ask some risk.
Bryan - I would say if it's a little scary, you're doing something right. Value-add scenarios are value-add for a reason. I agree that we go into them with eyes wide open and bring in whatever help we need in order to mitigate the risk.
If you're a value-add investor, expect to have to clean up a mess.
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You intermix most investors with new investors. I would say your assessment on most new investors not understanding value add is correct, but I wouldn't classify them as investors. In my experience, there is a very large portion of the investor pool that wants value add and understands what they are and how to evaluate them.
Originally posted by @Todd Dexheimer:
You intermix most investors with new investors. I would say your assessment on most new investors not understanding value add is correct, but I wouldn't classify them as investors. In my experience, there is a very large portion of the investor pool that wants value add and understands what they are and how to evaluate them.
That's fair. Maybe it's just been a fluke run, but it seems like I've spoken to quite a few this year. They are new to the commercial space, but not necessarily new to investing.
Great post. Interesting point.
If you are new in real estate investing and google "Turnkey" investment, most of the definitions falsely imply as if if you buy the property, everything is ready. You will not have to do anything. Wrong.... Simply wrong.
There are things the seller will not tell you or not have to tell you. Nothing is perfect.
As you point out, negative cashflow could be a great investment. It may be difficult to see the details of accounting unless you have some kind of agreement but if you have good experience and knowledge how to read the financial information properly, you can determine if the negative cash flow is a temporary such as a big fix on the roof or backflow. Now, you should ask the seller how they fixed it. If they properly fixed it and you will not have to fix them for another 10 yrs, there is a good chance of the property will become a positive cashflow going forward. If they didnt do the good job, things will keep breaking so it could go opposite.
@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.
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.
Originally posted by @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.
Well said, I agree