Understanding Value-Add Real Estate

Real estate investors have long pursued value-add projects—and for good reason. Not only do such projects offer the typical benefits of CRE investing, but they also deliver a boost in the investor’s return on investment (ROI) compared to stable (core) investments.

With specific knowledge and expertise, an investor has the opportunity to acquire a real estate property at below-market cost, make specific improvements, and ultimately increase the overall value of the asset. However, in order to succeed, an investor must achieve specific milestones related to such projects. We will review these milestones below.

1. Acquire the Property

The first milestone for completing a value-add project is to purchase the real estate. The goal is to identify and acquire a real estate asset that presents an opportunity for improvement. While researching assets that fit your profile, it is imperative to understand current CRE trends and legislation that may impact future investment opportunities.

Remember, adding value does not look the same for every deal—value can be added in numerous ways, and the required effort varies according to the project. However, the most common steps to improving a value-add asset include renovation and tenanting.

2. Renovate the Property

Once you’ve acquired the property, it’s time to renovate. Properties require different renovations, and you should consider the associated costs in the original underwriting. The most common renovations include painting, improving the use of space, re-flooring, etc.—essentially giving the property a facelift by focusing on aesthetic improvements.

An investor should also consider the following:

• Bringing the property up to code (including ADA upgrades)
• Replacing the roof
• Securing the foundation
• Upgrading to eco-friendly features (e.g., lighting, HVAC, solar, etc.)
• Repaving the parking lot
• Upgrading electrical and plumbing

The list goes on. In some cases, an investor may decide to demolish the property and perform a ground-up renovation. This, however, should be reserved for more savvy investors who are familiar with the development because permitting, tenanting, etc., can cause project timelines to extend, creating an immense financial burden for those involved.

3. Lease-Up the Vacancies

Upon completion of the property’s renovations, it’s time to lease-up the property. Occupancy when the building was purchased directly impacts the effort required to lease-up the property. Additionally, the type, location, and use of the asset impact which tenants will be interested in leasing. You should consider this fact during the acquisition process.

For example, if an investor acquires an office building in a secondary market with high vacancy rates in neighboring assets, tenanting the property may be difficult. However, if an investor acquires a rundown shopping center on a hard corner, re-tenanting after renovations should be easier. Again, you should consider all of this during the underwriting.

To rent the property, many investors turn to the aid of a professional leasing agent. Although it may be tempting to skip this step and lease the space yourself, we recommended using professional help. An agent who specializes in the product type and location of an asset can help a property owner develop an effective marketing platform. They also have access to a unique network of prospective clients, which allows them to obtain higher rents on the space.

Your goal, depending on the projections, should be to reduce property vacancy to zero percent.

4. Dispose / Recapitalize

Following renovations and tenanting, an investor has completed their value-add project. A property bought at a discounted price has now increased in value with a bit of work: It’s that simple!

Depending on an investor’s initial strategy, the market, and their position, they can either sell or hold the asset. Selling offers investors the opportunity to benefit from high financial returns. If they desire, they can conduct a 1031 exchange into a new value-add project to repeat the process. However, for some, holding the asset and improving their overall financial stability will suffice.

Benefits of Value-Add Investments

As mentioned previously, value-add real estate offers investors the chance to increase their ROI. Compared to core investments, which often trade below 5% cap rates in today’s primary markets, a value-add project can offer an investor the opportunity to earn a 10% or greater return. What’s not to love about that!

If you are an investor interested in learning more about value-add investment opportunities in Orange County, contact us today.