Value-Add Visionaries

Multifamily investors look far and wide for profit-building opportunities.

Commercial real estate pros shaking their heads over declining job growth and falling retail sales should remember that people always need places to live. Regardless of market indicators, multifamily is still the sweet spot for a wide range of investors. More than any other property, this sector offers numerous opportunities as a value-add investment at almost any price point. Once considered the province of small investors or a great starting point for new investors, value-add multifamily transactions now catch the attention of institutional and private-equity investors.

A look at several multifamily transactions around the country reveals the creativity on the part of brokers and investors to make value-add deals happen. But beyond the property type, about the only thing these deals have in common is their disappearing nature: From Hawaii to Massachusetts, CCIMs agree that good multifamily value-add deals are getting harder to find.

Value-Add or Condo Conversion?

Location: Honolulu
Purchase Price: $3,100,000
Bldg. Size: 13,684 sf
Units: 25
Cap Rate: 4.98%

“A diamond in the rough” is how Stanley Ching, CCIM, a broker in Pearl City, Hawaii, describes a 1962 property with 18 residential units and seven commercial ground-floor spaces. It’s also a value-add deal in the making. The owner originally listed the property for sale but withdrew it when no serious buyers materialized. “The current multifamily market is active but buyers are very cautious about their return,” Ching says. The owner decided to self-finance the renovation of six large studio apartments into one-bedroom units, transforming one unit at a time to maintain a positive cash flow. “The rents will be adjusted and the cap rate raised by about 1.5 percent based on the asking price of $5 million,” says Ching, who envisions a 1031 exchange investor as a possible buyer.

In addition, the property’s location near downtown and two new luxury high-rises makes it a candidate for condo conversion. “With one-bedroom condo units selling for more than $200,000, the whole property can be sold for more than $5.5 million in the current market,” Ching says.

Short Time Frame, Big Return

Location: Holyoke, Mass.
Purchase Price: $155,000
Bldg. Size: 10,600 sf
Units: 16
Renovation Costs: $191,750
Selling Price: $570,000

The secret to a successful value-add project is controlling risk, and Tim Thompson, CCIM, a broker with Infinity Real Estate Group in Holyoke, Mass., had a handle on just about all the potential risk factors when he and a partner began renovation of a class C building built around 1910. “I had a very good idea about the amount the property would sell post-rehab. We used projected rehab costs, projected disposition price, and a required yield to determine the amount we were willing to pay for the property,” he says. With a short turnaround time, Thompson and his partner financed the project with private funds instead of a bank. They even lined up a buyer before starting the rehab, “so the hold period was equal to the construction time frame,” he says.

The only what-if factor was the Holyoke apartment market. “Since we agreed to deliver the property to our take-out buyer at 75 percent occupancy, the stability of the rental market during the hold period was important to us.” Area multifamily properties had appreciated at an average annual rate of 10 percent to 12 percent during the two years prior, and rents increased approximately 2 percent to 3 percent during the same period. Fortunately the market remained strong during their hold period.

The renovations consisted of plumbing, electrical, and cosmetic upgrades in 12 units. In addition, they rebuilt the rear porches, replaced wood windows with vinyl, and upgraded the entire electrical service to the property. After eight months of construction, “We received a note from the buyer at closing equal to 10 percent of the sale price and secured by a second mortgage on the property. Our return on investment was approximately 48 percent over nine months, not including the $57,000 note. We are receiving interest-only payments on that note at a rate of 8 percent annually. The note balloons in 2010.”

Thompson says finding these deals takes perseverance. “Every deal must make sense for us financially. We refuse to stretch for a deal in that sense, and sometimes locating the right deal requires making a lot of offers.”

Secondary Market Success

Location: Nampa, Idaho
Purchase Price: $8,250,000
Units: 117
Renovation Costs: $300,000
Projected Return: 15% or higher leveraged internal rate of return over five- to seven-year holding period

Partnerships also find value-add opportunities attractive, but “In a clear seller’s market like Boise, [Idaho], finding value-add deals where the seller has not incorporated the upside into a sales price expectation is very difficult,” says Jim Vaughn, president of Maxim Real Estate Investments, which is sponsor and part owner of Orchard Place Apartments in Nampa, Idaho, a suburb of Boise.

In multibuyer transactions, the numbers have to work. “Maxim has evaluated a number of deals in this area but has had difficulty achieving a purchase price that will meet the targeted return threshold,” he says. Vaughn used a comprehensive acquisition pro forma analysis to determine the asking price. “The analysis took into account a number of key factors including market-driven rental rate growth, renovation-driven rental rate growth, occupancy growth, expense growth, cost of debt and a terminal sales price. The aggregate IRR of the model drove the price that the investment group was willing to offer.”

When the partnership considered renovations for this 1997 property, it looked particularly at those that would drive additional revenue. Upgrades included the installation of in-unit washers and dryers, carpet and vinyl replacement, and renovation of the property clubhouse.

After implementing the improvements over a two-year period the partnership is looking at two to three years to achieve operating stability, but Vaughn concedes that if the Boise market remains strong, they could shorten the hold period. Although a regional or local investor will be the most probable buyer, the group is considering amassing a portfolio of such properties. “If the attitude of multifamily REITs evolves toward strong secondary markets, a portfolio sale to a major owner might be possible.”

Improving an Image Problem

Location: Albany, Ore.
Purchase Price: $1,845,000
Units: 40; 6 buildings
Cost of Renovations: $175,000
Projected Return: 15 percent IRR after five-year holding; cash-on-cash return after improvements: 8.5%

A $2 million property with an image problem in a secondary market might seem a hard sell — and it was initially, says Tom Davies, CCIM, senior investment broker and partner with Norris & Stevens in Portland, Ore., who was looking for a 1031 replacement property. “My client was looking for a cash-flow deal, so this type of building was not within his initial parameters. He was comfortable with multifamily but not with a value-add building. The reduced cash flow during the first year of renovations was a hurdle we had to get him to accept.”

The property’s overflowing trash container had made the local newspaper’s front page, along with tenant complaints. Owned by a pair of squabbling partners, the property suffered from management and maintenance problems. Davies says the asking price was high considering the building’s physical condition. However, a list of renovations that he developed led to a $255,000 price reduction for his client.

After selling the buyer on the property, it was time to sell the bank. “Financing was difficult, because Albany is a secondary market and the property had a poor operating history,” Davies says. Several lenders rejected the property, despite a supportive rent survey that revealed rents as much as $100 below market in an area where most buildings were 95 percent occupied. Finally a bank with a strong local presence and experience in this market approved the deal. Davies’ company oversaw the work completion. “The renovations preserved the value of the asset, the curb appeal, and the ability to raise the rents,” Davies says.

Davies played a big role in making this deal happen, but, he says, that’s what it takes. “These deals require considerably more due diligence than typical transactions. I had to act as a general contractor to determine the total dollar amount required to bring the property back in line with the market and determine a reasonable purchase price.”

C Property, B Location

Location: Lexington, Ky.
Purchase Price: $6,840,000
Units: 228
Renovation Costs: $800,000

Upon hearing this property was going into foreclosure, Ken Silvestri, president of Silvestri-Craig Realtors in Lexington, “called the defaulting owner to find out which bank controlled the paper. I knew I could find a buyer.” Coincidently at the same time Silvestri heard from a new investor in Tacoma, Wash., who was flying into Lexington to look at properties.

The property was already on the road to recovery. “Amazingly, the seller had brought a new management company to turn the place around. The bank invested $100,000 to get the 84 vacant units ready to rent,” Silvestri says. Most of the renovations were cosmetic, replacing “soiled carpets and cheesy kitchens with overpainted counters.”

While the buyer eventually had to add another partner to get financing, the property’s value “will definitely go up to around $45,000 per unit in 18 months to two years when stable,” Silvestri says. “We have an emerging market here in Lexington with solid barriers to entry. The opportunities here now are to upgrade C properties to B, buy for $30,000 [per unit], and sell for $50,000 in three to five years.”

Land Banking

Location: Las Vegas
Purchase Price: $18,500,000
Units: 210
Cap Rate: 7%

A multifamily specialist for Coldwell Banker Commercial ETN in Las Vegas, Gary Banner, CCIM, concentrates on value-add deals and has plenty to keep him busy in that growing market.

A recent transaction, Cambridge Towers, is located just a half-mile from the Las Vegas Strip and adjacent to a parcel being developed into midrise condos. “My advice to the [buyer] was basically land banking for future condo conversion as the local market recovers,” he says. And, like most good brokers, Banner didn’t wait for the property to come on the market. “I arranged a non-solicited offer based on my impression that that the owner would be interested in selling.”

It became a be-careful-what-you-wish-for situation: A short time frame, more renovations than initially perceived necessary, and a loan defeasance. “The defeasance was the easiest part,” Banner says. A property inspection revealed “many issues that required attention upon closing and some that required it during escrow. We had a short fuse on due diligence and that required getting accurate estimates quickly.”

Interestingly enough, a few weeks after the closing, the new owners received an unsolicited offer. “I had several calls inquiring about the project,” Banner says. “Many of my prospects mentioned that if they had known the property was available they would have made a run for it.”

Multifamily Value-Add Opportunities

MSA Median $/Unit
Denver 71,300 Arvada/Broomfield submarket
Indianapolis 30,200 B and C properties adjacent to downtown and the two universities
Las Vegas 95,700 C properties with below-market rents
Miami 94,400 Rising rents and cap rates
for B and C properties
St. Paul
63,400 Small, older infill properties
selling below replacement costs
New Haven County, CT 71,800 B and C properties in
Waterbury and Meriden
Sacramento 83,200 B and C assets in West University
and Rancho Cordova submarkets

Source: Marcus & Millichap


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