Here is a top real estate investment secret for you…
When I am on the lookout for new properties to invest in I always look for ways that I can add value. I favor the value-add real estate model.
This has worked well for me every time and it will work for you too.
Is it possible to add value to every property?
Technically yes; but it is not just about adding new coats of paint.
You have to be patient with real estate investment. Finding the right property often takes time, and if you are new then it can be very frustrating looking at one property after another and not finding anything that really “grabs” you.
But that is the name of the game!
When I look at a residential property, I always ask myself “would I be happy to live here?” If the property is not in the best condition and needs some renovation then the question becomes “with the rehabbing work that I have in mind would I be happy to live here?”
If you wouldn’t be happy to live in a property then how can you expect other people to want to live there?
OK there are people that are on a budget in the rental market and will put up with almost anything. If you are in that market then you are probably going to have to show your properties to a lot of potential renters before someone agrees to take the deal.
This is not something I would recommend.
What is a Value-Add Real Estate Investor?
I have seen several definitions of a value-add investor. In terms of real estate, a value-add investor will look to increase their yields by capitalizing on the untapped potential for revenue.
They are all about creating value with a property. This can be achieved through upgrades for example.
There are usually a lot of value-add real estate opportunities in the multifamily sector. Over the last few years, sales of multifamily value-add properties have risen significantly.
To be successful in the value-add real estate sector you need to have a thorough knowledge of the market, have a creative vision for property enhancement and be disciplined.
What does Value-Add mean in Real Estate?
Value-add real estate investing is about seeing a current property for the potential that it offers. You perform some upgrades to a property to make it more valuable to renters or buyers.
It may also be possible for you to identify additional revenue streams from a current property. A good example of this is creating another area of the property that you can rent out.
You can take a short-term or a long-term view with value-add real estate investment. If you are into flipping houses then you can purchase a property with good potential, carry out the necessary rehab and then sell it for a quick profit.
The rehab increases the value of the property on the market.
The long-term strategy is buy and hold which I will focus on here. You purchase a property that you have a vision for and get all of the rehab work done. This will position your property at the high-end of the rental market and you should be able to charge the highest rents.
When you enhance your property in this way, you are likely to increase its long-term value as well.
It is not about Gold Trimmings
Look I am not suggesting that you fit out all of your properties with chandeliers and gold trimmings. That’s not what it’s about.
But any property that I show a perspective renter or buyer needs to look clean, have everything that they need and feel like it would be really nice to live there.
You will be surprised about the kind of transformation you can make to a property for a fairly small outlay. If the property is structurally sound (which it needs to be and you need to check this) then you can add a lot of value by conducting a thorough clean and adding tasteful decoration.
When I say a thorough clean, I mean really thorough. You can get a professional cleaning company in that will clean every nook and cranny of the property.
If you want to do this yourself then that’s fine but be prepared for some hard work. It is a lot more than wiping surfaces clean.
The two rooms that will sell a property (or persuade a renter to rent it) are the kitchen and the bathroom. If either of these look shabby in any way then you are going to struggle.
With a lot of my properties, I completely replace old kitchen and bathroom fittings with new ones and add new tiles as well.
When the rooms in your property look clean and new you will be able to sell for the highest price or demand the highest rents. It will not take long to make a deal either as prospective buyers or renters will love what you have done and will want to move in straight away.
You need to Develop a Vision
Some real estate investors will be naturally able to do this from the start and for others it will take a while to gain the necessary experience. I can look at a property now and have a vision about how I can transform it to how I want it to be.
Not every property is going to be suitable for this which is why you need to be patient. I am involved heavily with the multifamily strategy, particularly dividing suitable properties into multiple rooms. In the UK this is known as the HMO (house in multiple occupation) market.
So, when I am looking for a suitable property it needs to have the potential to fulfil my vision.
These properties are large, and the idea is that you can convert them into a number of different rooms which you then rent out to multiple tenants.
One of the things that I pay particular attention to is “private space”. Although people will share a bathroom it is never their preferred option. So, I think about how I can add an ensuite to every one of the rooms that I want to rent out.
Then there are communal areas. It is always a good idea to have a place where the renters can relax, meet up and get to know each other. Most renters appreciate a nicely decorated and appointed communal area.
When I am assessing a new property, these are things I think about and how using the value-add real estate model can help me fulfil my vision.
How do Real Estate Investors Add Value?
So, when you are looking at different properties to invest in think about how you can add value. Here are some of the things that I think about when considering the purchase of a property:
Can I Add more Rooms?
I have already discussed adding a private bathroom for all of my renters but you can think about other rooms here. Is it possible to add another bedroom so that you can rent it out to another renter?
Does a cellar or a basement exist that you can transform into a recreation room? Can you add an extension to the property?
How is the yard looking? Is it overgrown or just a patch of grass? Can you do some landscaping to make it look inviting? A good-looking yard area will certainly add appeal to your property.
The External Appearance
How does the property look from the outside? Does it look tired with paint peeling off and other problems? When people come to view a property, the first thing they see is the outside.
If it doesn’t look too good then this will put them off no matter how good it is inside. Make the outside of the property look as good as possible.
These days people have a lot of stuff. They will look at a property and think “can I keep all my stuff in this place?” So, you need to think of ways that you can provide extra storage.
Built in wardrobes for example? What about storage space under the stairs? There are lots of different things that you can do here.
Give People what they want
Think about all of the things that people need to do at home. They need to prepare and cook meals, wash and dry their clothes, wash their dishes, store food properly, bathe in privacy and so on.
So, provide useful appliances such as washer / dryers, a dishwasher, a good stove for cooking etc.
Make each room look clean, bright and appealing. Add fresh paint in neutral colors as these will appeal to most people. Make sure that bathrooms and kitchens sparkle. If carpets are tired looking then replace them. Wooden floors can be a good choice.
Adding Value is a Good Investment
Yes, it will cost you money to add value to your property but usually not as much as you think. Focus on how easy it will be to sell or rent your property for the price that you want if it looks great and provides people with what they want.
A Value-Add Real Estate Example
If you are still undecided about value-add real estate investing then let’s take a look at an example to get your juices flowing. The first thing that you need to understand is that when you enhance a property for higher rental income, you are also very likely to increase the market value of your property as well.
The expert view on this is that if you can increase your net operating income (NOI) by just $1 a month, this should increase the market value of your property by at least $200. In reality, this can turn out to be a lot higher.
The example that I am going to provide to you is based on capitalization rate or “cap” rate.
If you are unfamiliar with this term, it is all about the return on investment that you will make on a piece of real estate once you have added value to it.
In order to calculate the cap rate, you need to estimate the net income which you believe the property will generate for you. You can calculate this from the NOI divided by the asset value of the property. Cap rates are expressed in percentages.
OK I need to make an assumption here.
Let’s assume that the average cap rate for a single-family property for rental is 6%. You now know that the cap rate is calculated by the NOI divided by the property asset value. To calculate the asset value, you need to divide your NOI by the cap rate.
You have invested in value-add real estate and you estimate that after all of the rehabbing you can increase your NOI by $2 each month. So, the formula becomes:
NOI increase $2 / cap rate of 6% = $33.33. Now we need to multiply this by 12 for a year which is $400. This means that your value-add project will raise the asset value of the property by at least $400.
Of course, it is unlikely that your value-add work will only increase your NOI by $2 a month. What if you were able to increase this by $15 a month? This would increase your asset value by a minimum of $3,000. If you could increase your NOI by $120 a month (this is realistic) then the asset value increase would be a minimum of $24,000.
That’s more like it!
Value-Add Real Estate Returns
The key takeaway here is that making even the smallest improvement in your NOI through value-add is always worth it.
By choosing a property that has the right potential, you can increase your monthly NOI by a significant amount which will have the knock-on effect of increasing your asset value substantially.
When you choose to invest in value-add real estate, the potential returns are certainly there for you. But you need to be consistent with your efforts.
Waiting for the right property can certainly be an issue, but you can increase your chances of finding potential value-add projects by putting the forming the right real estate team.
I hope you found this article on the value-add real estate model useful? I would love to hear your thoughts or about experiences. Please add them to the comments section below.
Thank you and have a great day.