An Altruistic Approach to Multifamily Investing

In a previous article we discussed the investment strategies that sponsors employ to preserve and generate wealth for their investors. One of these strategies is the value-add strategy, which, when executed successfully provides a favorable blend of current income and appreciation without assuming excessive risk.

In this post we’ll delve into the thought process guiding this investment strategy, identifying ways to increase profitability by creating value and eliminating waste, and understanding how this can be beneficial to both investors and tenants.

As a recap, a value-add investment strategy requires an active approach to creating value by making strategic improvements to properties with upside potential. These properties are often older, mismanaged, or undercapitalized, and can benefit significantly from a strategic repositioning plan. But how do we identify these opportunities to create value?

The process starts with understanding how multifamily properties are valued, which emphasizes the importance of understanding a property’s Net Operating Income (NOI).

When considering a new acquisition, it’s best to review the property’s historical income statement. This gives us a sense of how the current owner has been performing on collecting rents and the amount they’re spending on each of the major expense categories. Most importantly, it’s a great starting point to determining where we can create value (increasing revenue) and eliminate waste (reducing expenses).

Reducing Expenses – Eliminating Waste

One way to increase a property’s value is to reduce expenses without negatively impacting revenue. The balance is crucial because cutting operating expenses at the expense of revenue fails to create any real value and can harm both investors’ returns and tenants’ living conditions.

For example, using cheap parts and labor to quickly turn over apartments might lower immediate costs, but can lead to more maintenance issues, higher turnover rates, negative reviews, and ultimately, lower occupancy and rental income. This example illustrates how improper expense savings can undermine a successful business strategy.

Effective expense reduction focuses on eliminating waste. A literal example of this is reducing water usage by replacing outdated toilets with newer low-flow models. Older toilets use significantly more water per flush, so updating these can substantially lower water bills and improve NOI. You’d be surprised at exactly how much you can save across a property on such a low-cost improvement.

Sponsors that only focus on the revenue side of the equation aren’t fully maximizing ways to improve a property's NOI.

There are many opportunities to lower your expenses with minimal upfront costs. Here are some examples:

• Comparing bids of your existing vendors with others in the market.

• Reaching out to your local county for tax-saving credits.

• Identifying work that can be completed by in-house maintenance staff to replace third party contractors.

• Scoping your sewer lines to identify water leaks.

• Performing routine maintenance on equipment to prevent deterioration.

• A mindful sponsor consistently monitors and reviews expenses to ensure that a property is operating efficiently. Technological improvements and new strategies can always be adopted to make a property run more efficiently.

Increasing Revenue – Creating Value

Maximizing revenue involves maintaining stable occupancy, ensuring on-time payments, and enhancing tenant satisfaction to justify higher rents. This can be achieved by making the property and its respective apartments more valuable to tenants. Understanding which upgrades are most valuable requires knowledge of your tenant base and local market preferences.

Investing in improvements is an effective way to increase revenue, but it’s important to understand which upgrades are worth the investment. This is accomplished by understanding and catering to your tenants’ values and preferences, and these may vary depending on the market location. For example, tenants in some markets may value high-quality interior finishes, whereas in others they may be indifferent to them altogether.

The incremental increase in rent that a tenant is willing to pay for an improvement is the monetary value your tenant assigns to it. By comparing the cost of the improvement to this monetary value, we can focus our time on making the most valuable improvements to the property.

The monetary value tenants assign to improvements is determined through local market research. By reviewing comparable properties in the market, you can note the differences between each and then draw a comparison of the rental rates for each unit.

If you have two identical properties with two identical unit types, and the only difference between them is that one of these properties has a swimming pool, you can compare the rents of both properties and reasonably determine that the difference in rents is the value that tenants in this market assign to having a swimming pool on the property. If the cost to install a swimming pool at your property yields a positive return on cost, then it may make sense to incorporate this in your business plan for your property.

In real practice, we’re never so fortunate to have perfect examples like the one provided, but we can get surprisingly close to a relative range by drawing multiple comparisons across several properties in the market. In major cities with multiple properties for comparison, it will be much easier to determine these rent variances than tertiary markets with very few properties and less data points.

Conclusion: Aligning Upgrades with Tenant Values

Ultimately, the success of a value-add strategy hinges on a deep understanding of what tenants in your specific market truly value. By conducting thorough market research and making data-driven decisions, you can pinpoint the improvements that will yield the highest returns. This means not only focusing on revenue enhancements but also strategically reducing expenses in ways that do not compromise the quality of living for your tenants.

Listening to tenant feedback, conducting surveys, and staying updated with market trends are practical steps to ensure your investments are aligned with tenant desires. Modern amenities such as high-speed internet, in-unit laundry, or energy-efficient appliances might be highly valued in urban areas, whereas suburban tenants might prioritize larger living spaces or community-centric features like parks and recreational facilities.

By continually reassessing and aligning your property improvements with tenant values, you can create a win-win scenario: enhancing the living experience for tenants while driving up the property's NOI and, consequently, its market value. This balanced approach not only attracts and retains high-quality tenants but also secures steady, long-term returns for investors. The key takeaway is that a well-executed value-add strategy is as much about understanding and serving your tenants as it is about financial acumen.

If you’d like to learn more about how you can make your first multifamily investment, please fill out our contact form and one of our team members will reach out to you for an introductory call.