Value Add Investing – How do you do it?

[Benjamin Riehle]

Value-add in real estate is one of the most common strategies when it comes to investing in real estate. The concept is simple but if you’re not familiar, it’s going into a property that’s underperforming (rundown or neglected) and identifying ways to increase the value of a property. It could be as simple as “Neutralizing” the paint colors (gray, tan, white, etc.), to as large as doing a complete remodel or addition with the intention of increasing rents and/or resell value.

The benefit of doing this is that the investor can now introduce bank financing (I.e. Leverage). The goal in value add investing is to increase the value enough to return the investors initial capital invested when the property is re-financed. As a result, the investor can propel the capital received from the re-fi and do the same strategy over and over and over again. This strategy is very common for investors who want to maximize their purchasing power. With this strategy the investor can get their initial investment back while also adding strong performing assets to their portfolio. The common acronym for this type of investing is the BRRR Strategy (Buy, Rehab, Refinance, Repeat).

Recently, we ran into a great value add opportunity. The property is a 61-unit apartment complex that has had the same owner for over 30 years and was very mismanaged. Right away, we were able to raise rents (VALUE ADD #1). Second, although the units were in decent shape, they lacked central air, a must in Tucson, Az. By adding central air to the units we will be able to increase rents another $125-$150 per month (VALUE ADD #2) Lastly, although the units were in decent shape, the location of the property lends itself very well to higher end tenants. As a result we are planning on modernizing the units (installing bar tops, granite countertops, etc.), and doing exterior updates that supports a cleaner/sleeker look (VALUE ADD #3).

By doing this renovation we expect to greatly increase the monthly rental income and as a result, substantially increase the value of the property. Making these improvements and managing the property at a high level, we expect to be able to return our entire capital outlay.

Keep in mind; the updates I mentioned above will take time. While updating the exterior can happen quickly, it’ll take around two years to get the property where it needs to be in terms of finishing the entire remodel and increasing rents. Once that happens, we are able to refinance. With our current market and its suggested appreciation, the financials suggest that we can pull out our entire initial investment into the property with a refinance. Because of this, we’ll be able to take that same capital used for the 61-units and apply it to another property.

Many may read this and think that this is possible solely because it’s a 61 unit complex but that’s simply not the case. This strategy can be used in single-family homes, 2-4 units, and 5+ units. This strategy is very powerful and it allows an investor to build their portfolio!

Question: How have your experiences been with value-add investing? What has worked? What hasn’t?