A Value-Add Strategy in Action
Here’s how a value-add strategy can pan out on an apartment complex:
Let’s say we purchased a 100-unit apartment building and were able to implement improvements to the units that cost us $10,000 per unit, which allows us to raise the rent by $100/unit.
If this property is in a market where the cap rate is 5%, just apply our valuation equation: Increase Rents +$100/unit 12 months X12 # of Units X 100 Annual Rental Income Increase = $120,000/yr Net Operating Income $120,000/yr Cap Rate /.05 Value =$2,400,000 So, through this investment of $1 million, we have increased the property’s cash flow by $120,000 per year, but even better, we have increased the value of the property by $2.4 million—a 140% return, more than doubling our $1 million investment!
This doesn’t only work on large apartment complexes. Here is a real-world example of how this worked on a 6-unit property that I purchased. During our due diligence phase, the residents were given a few days’ notice that inspections of the units were going to take place. Overall, they were in good condition, except for one unit. Entering this unit with the inspection team is sort of a blur to me. There were a lot of people there. I remember there was someone passed out on the couch—this was at mid- day during the week. The unit itself was a shambles, filthy and disgusting. The unit had a washer and dryer and the dryer had been ruined. These residents had been in the unit for a few years. Their rent was below market and below the rent of the other two-bedroom unit in the building, even though this unit was a little larger and could be nicer than the others. I knew that whenever these residents moved out, we could do a nice renovation on the unit and achieve much higher rent. I would never kick them out, but I thought that within a few years they might move out on their own.
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