The Capital Stack
Value-Add VS Stabilized
Most multifamily will be determined a value-add property or a stabilized property. Primarily, Sheffer Capital focuses on purchasing Value-add properties. We truly enjoy the challenge and satisfaction that a value-add project can offer.
Value-Add & Stabilized Defined
True to its name, a value-add property is simply one where you can “add value”. Usually, the buildings are older and have some deferred maintenance. This works to our advantage, and we can add value through interior and exterior renovations. If the property is mismanaged, we may also be able to achieve operational value-add. The best value-add opportunities allow for all three types of value-add.
A stabilized property has consistent, strong occupancy usually ~95%. All tenants at a stabilized property are paying within ~5% of market rent. In most cases, the property has little to no deferred maintenance, is recently renovated, or built within the last 10 years. Royal Oakland is a 20-unit property we own in Royal Oak. We bought this property in August of 2020 and completed the renovations and leased all of the units at full market rent, then closed a refinance in February of this year, which we wrote about in detail HERE.
We have found that we are able to obtain more favorable loan terms with value-add projects. Once, we present the bank with our business plan including our renovation budget and projected rents we are likely to secure a loan in the maximum amount of 75% of the projects completed value. With a stabilized project the bank is likely to follow its built-in metrics following DSCR alone and will most likely offer us a loan around 60-70% LTV. On a value-add project, once the renovations are completed and target rents achieved, we can refinance at the DSCR requirement of 1.25 and pull out most or all our initial equity plus any profits.
With value add there is “more meat on the bone”. We can force the value of the property higher with physical improvements rather than just rent increases. The key to buying value-add is in the location. A property needing physical improvements in Class A locations can achieve the highest rent increases and the highest property value once renovations are completed.
The Reality of Value-Add
Value add projects are not always roses and butterflies. From an operator’s standpoint value-add projects require significantly more time and effort. There have been several moments, mostly during slow-moving construction projects, where we have threatened to never purchase a value-add property again, but we recognize this as an empty threat because historically value-add properties provide the highest return for us and our investors. Most of the extra time and effort needed on a value-add project is required in the first 8-12 months (while renovations are underway). In addition to taking over leasing and standard management practices the operator is also overseeing a heavy construction project. Our two biggest value-add projects have been the Harvard Lofts (Royal Oak, 8-units) and the Cambridge Apartments (Ferndale, 14-units). Both properties required complete gut renovations and when completed will be beautiful high-end apartment homes. We were able to take advantage of exterior, interior and operational value-add on both projects. Harvard Lofts and Cambridge Apartments are in two of the best locations in Michigan.
Our most recent purchase the Suburban 36 portfolio has been the lightest value-add project to date. The amount of time spent managing/operating this portfolio is substantially less than our typical Value-add Project. Suburban 36 is a “diamond in the rough” because we can achieve significant rent increases without a large renovation.
Major Market News
Chicago Apartments sell for $74 Million
According to an article by the RealDeal. A gentleman by the name of Friedman who is the head of F&F Realty purchased 504-units in the suburbs of Chicago for $74 Million. According to the article the property “was marketed as a value-add play, meaning Friedman’s venture could boost its rental income by investing in renovations and upgrades of a property built in 1971.” Check out the article for more information on this huge value-add project.
Tips and Tricks
When looking to purchase value-add be sure you are purchasing “true value-add” ideally built in the 1970’s with all original units. Many properties listed for sale on Zillow, Co-star etc. are advertised as being value-add opportunities. However, some already have most of the value-add completed or there is not enough physical improvements needed to achieve a rent increase. Brokers love using this term as a keyword when selling because buyers will immediately start to look for upside.