Author: New Level Investments

Once you get wind of real estate syndications and you begin thinking about the possibility of investing passively in them, it’s natural to simultaneously have questions… lots of questions.

Investing in real estate is a big deal and you SHOULD have and ask ALL the questions. Furthermore, real estate syndications aren’t broadly popularized, so, not only will your friends probably not have any answers to your questions, but they likely will have no idea what you’re even talking about.

For this exact reason, it’s important you find a trusted, knowledgeable resource to get your questions answered and do plenty of your own research. In an attempt to make this easier on you, we’ve addressed 4 big questions today:

• What types of properties can I invest in using syndications?
• What risky downsides are there to syndications?
• Where and how do I find syndication deals?
• Can I invest in syndications online?

The answers to these 4 simple questions are going to clarify so much for you… we can feel it! Ready? Let’s dive in!

What are the different types of real estate syndications?

Real estate syndication deals are available on multifamily properties, self-storage, manufactured home parks, land development, hotels, student housing, warehouses, and more. Some real estate syndications are for ground-up construction and others are for buy-and-hold (i.e., buy an asset that’s already stabilized, and hold it for a number of years).

A great example of a value-add multifamily deal is an apartment community whose units haven’t been updated in ten years. The kitchens are all dated, the carpets are worn, and the landscaping needs some work.

By making those improvements, we can increase the rents, which increases the income of the property and thus, the overall value.

What are the risks of investing in real estate syndications?

You’re no dummy, you already know any type of investment is a risk. Syndications aren’t immune to risk either.

One of the biggest risks lies in the execution of the business plan. Before the deal, you’re wooed with glossy marketing packages and the sponsors will answer your questions with lofty ideals.

However, when the rubber meets the road, the sponsor team needs to be able to execute on the business plan in the face of unforeseen circumstances. Investing with sponsors who have a proven track record and who prioritize capital preservation helps ensure that they will protect your investments and do what they say they’re going to do.

Changing market and economic conditions are always a risk. No one can predict what market conditions will be like at the end of a project’s hold time.

This means, if the projected hold time is 5 years, check to make sure that the loan term is for at least that long, and ideally longer than 5 years, so there’s a buffer in case sponsors need to hold the property longer than intended.

At the end of the day, as a limited partner passive investor, you’re concerned with your personal liability. The good news is your liability in real estate syndication is limited. At worst, you could lose your original investment capital, but you could not lose more than that (e.g., you can’t lose your house).

Where can I find real estate syndication opportunities?

The only publicly advertised real estate syndication deals are for accredited investors only. So, how does a “normal person” find real estate syndication deals?

You can do a Google search, but how do you know that the opportunities that pop up are legitimate ones, put together by experienced teams with strong track records, who will safeguard your money over a period of several years?

You don’t.

The best way to find real estate syndication opportunities is to get out there and talk to people in the real estate syndication space. This community is quite small, and once you get connected, you’ll easily be able to find sponsors and real estate syndication opportunities that fit with your investing goals.

How do private real estate syndications compare to real estate crowdfunding sites?

Maybe one of your friends claims they invested in a syndication deal for just a few thousand bucks. This is because recently, real estate crowdfunding sites like RealtyMogul, RealtyShares, and Fundrise have helped make it possible for millions of people to invest passively in real estate.

Real estate crowdfunding sites can be a good place to find real estate syndication offerings. However, there are a few things you should keep in mind.

First, most of these platforms require that you be an accredited investor in order to invest in their real estate syndication offerings.

Some of these platforms do offer REITs (real estate investment trusts) as an alternative for non-accredited investors. Typically, you can invest in these REITs with a low minimum investment (you can invest in Fundrise’s eREIT for just $500).

Just be aware that REITS are not real estate syndications. Rather, it’s a fund, which is likely what your friend actually invested in.

When you invest in a REIT, you’re investing in a company that buys real estate; you don’t have direct ownership of the underlying asset yourself, like in a real estate syndication. You would likely still get good returns, you would be investing in a bunch of assets rather than a single one, and you wouldn’t get the same tax benefits as with a real estate syndication.

Regardless, if you’re just starting out, you should definitely check out some real estate crowdfunding sites, to see what they’re all about.

In Conclusion

All in all, it’s important to understand the risks, the terminology, the options available, and how to find the deal that fits your goals and investing style best. Real estate syndications aren’t for everyone, but they can be a fabulous addition to anyone’s portfolio. Now that you know more about how to find and passively invest in real estate deals, that’s one more checkbox checked and one less barrier to entry. At this point, what are you waiting for?

Many real estate investors “get their feet wet” through some form of residential real estate. Whether those initial investments are flips, standard rental homes, or even duplexes, that’s a great start. But we recently met someone who’d been in the real estate investing game for over 10 years and had never heard of a “real estate syndication” before.

Actually, that’s pretty common. Until somewhat recently, SEC regulations did not allow for real estate syndication opportunities to be publicly advertised. This made it so, you had to be part of the “inner circle” (i.e., you had to know someone who was doing a deal) in order to invest in one.

Luckily, the SEC now allows certain opportunities to be publicly advertised, which opens the gates for more people to learn about and invest this way.

But maybe you’re new to this term too and are wondering things like:

• What is a real estate syndication?
• How does a real estate syndication work?
• Why should I invest in a syndication deal?
• What would an example real estate syndication look like?

 

A Real Estate Syndication – What’s That?

Let’s start with the basics. The term syndication means pooling resources. A real estate syndication is when a group of people pool their funds and expertise together to invest in a real estate asset together. Instead of buying a bunch of small properties individually, the group of people come together and buy a larger asset together.

Let’s pretend you have $50,000 for investing, beyond other savings and retirement funds. You could invest it in an individual rental property, but that would also require time to find a property, negotiate the contract, do the inspections, run the numbers, get the loan, plus find the tenant and manage the property.

But it’s likely you don’t have the time or energy to deal with such an obligation. This is where most people assume real estate investing is too hard and too much work, so they stop there.

Real estate syndications are the alternative that allow you to still put your money into real estate, without having to do the work of finding or managing the property yourself. Instead, you can invest that $50,000 into a real estate syndication as a passive investor. So you contribute $50,000, maybe a friend has another $50,000 to invest, someone else puts in $100,000, and on and on.

By pooling resources, the group would now have enough to buy not just a rental property, but something bigger, like an apartment building. As a passive investor, you don’t have to do any of the work managing the property. A lead syndicator or sponsor team does the day-to-day management (i.e., all the active work), and in return, they get a small share of the profits.

When done right, real estate syndications are a win-win for everyone involved.

 

How Does A Syndication Deal Work?

Now you’re interested in the “behind the scenes” details of a syndication to see how this all really shakes out.

First off, there are two main groups of people who come together to form a real estate syndication: the general partners and the limited partner passive investors.

The prior section mentioned a team that would take care of all day-to-day management (so you don’t have to!) in exchange for a small share of the profits. That syndication team is made up of general partners (GPs). They do all the legwork of finding and vetting the property and creating the business plan. Essentially, they do the work that you would be doing as the owner and landlord of a rental property, just on a massive scale.

The limited partners (LPs) are the passive investors (others like you), who invest their money into the deal. The limited partners have no active responsibilities in managing the asset.

A real estate syndication can only work when general partners and limited partners come together. The general partners find a great deal and put together an efficient team to execute on the intended business plan. The limited partners invest their personal capital into the deal, which makes it possible to acquire the property and fund the renovations.

Together, the general partners and limited partners join an entity (usually an LLC), and that entity holds the underlying asset. Because the LLC is a pass-through entity, you get the tax benefits of direct ownership.

Once the deal closes, the general partners work closely with the property management team to improve the property according to the business plan. During this time, the limited partner investors receive regular and ongoing cash flow distribution checks (usually every month).

Once all the planned renovations are complete, the general partners sell the property, return the limited partners’ capital, and split the profits.

 

Why Should You Invest In A Syndication?

Okay, now that you’ve got a decent understanding of how real estate syndications work, let’s talk about what’s in it for you. There are a number of reasons that passive investors decide to invest in real estate syndications.

Here are a few of the top reasons:

• You want to invest in real estate but don’t have the time or interest in being a landlord.
• You want to invest in physical assets (as opposed to paper assets, like stocks).
• You want to invest in something that’s more stable than the stock market.
• You want the tax benefits that come with investing in real estate.
• You want to receive regular cash flow distribution checks.
• You want to invest with your retirement funds.
• You want your money to make a difference in local communities.

A real estate syndication is a nearly perfect way that a busy professional can invest in large-scale, physical real estate assets, without the commitment of time or excessive mental energy, while also positively impacting the community and earning interest and tax benefits. This opportunity for passive income is sounding better and better.

 

An Example Real Estate Syndication:

Okay, so you’re interested, but you’re still like, “Is this real?” Here’s an example of what a real estate syndication deal would look like.

Let’s say that Jane and John are working together to find an apartment community in Dallas, Texas. Jane lives in Dallas, so she works with real estate brokers in the area to find a great property that meets their criteria. After looking at a bunch of properties, they find one, listed at $10 million.

John takes the lead on the underwriting (i.e., analyzing all the numbers to make sure that the deal will be profitable), and they determine that this property has a ton of potential.

Since Jane and John don’t have enough money to purchase the $10-million property themselves, they decide to put together a real estate syndication offering. They create the business plan and investment summary for prospective investors and work with a syndication attorney to structure the deal.

Then, they start looking for limited partner passive investors who want to invest money into the deal. Each passive investor invests a minimum of $50,000 until they have enough to cover the down payment, as well as the cost of the renovations.

Once the deal closes, Jane works closely with the property management team to improve the property and get the renovations done on budget and on schedule.

During this time, Jane and John send out monthly updates, as well as monthly cash flow distribution checks, to their passive investors.

When the renovations are complete, Jane and John determine that it’s a good time to sell and the property goes for $15 million after just 3 years. Each passive investor receives their original capital plus their split of the profits according to the original deal. In this case, a 70/30 split was agreed upon at the outset of the syndication (70% to investors, 30% to the Jane and John).

At this point, each passive investor has received monthly cashflow checks during the renovation and hold period, plus their initial capital investment back once the property sold, plus their portion of the profit split after the sale…a pretty sweet deal for little-to-no work!

 

In Conclusion

Now that you know the ins-and-outs of a real estate syndication, including what it is, how it works, how little effort on your part it requires, and how simple it could be to begin receiving your first passive income check, definitely don’t wait 10 years to make a move.

We always recommend you research until you’re comfortable and that not all your eggs are invested in one basket, so to speak. Now that you’re armed with this knowledge about real estate syndications though, you’re miles ahead of most other investors. Keep at it!

You’ve been devouring all the information possible and have nearly become enamored with the power of passively investing in real estate syndications. How could you not?

The ability to invest in real, physical assets without being a landlord, getting a share of the majority returns, and reaping amazing tax benefits is a pretty shockingly sweet deal. Plus, the diversification opportunities with minimal legwork while making an impact on local communities is pretty attractive.

Even though these traits seem impossible to pass up, real estate syndications aren’t for everyone. Each investor is in a different stage of life, has a different level of risk tolerance, and maintains different goals.

Before investing in a real estate syndication, see if one or more of the below describes you and your current situation.

#1 You Have More Than $50K of “Play” Money

While there are some real estate investment platforms that will accept smaller investment amounts, most private real estate syndications begin at a minimum investment of $50,000.

Ensure you have the minimum investment of $50,000, plus your standard emergency fund, plus any other savings for your life’s aspirations. Think about it – a new car, fluffy retirement savings, this year’s vacation to Cabo, and college education funds, to list a few.

Of course, there are lots of contingencies in place in syndications, but if you aren’t prepared to lose your investment in its entirety and be okay financially, then syndications may not be your jam…yet. You might want to head back to the drawing board with some serious savings plans and re-visit real estate syndications in a year or two.

On the other hand, if you have all the potential cash-needing scenarios covered with stacked savings, by all means, invest with confidence!

#2 You’re Okay Having Someone Else Take the Reins

If you’re short on time, but heavy on cash, and want someone else (a professional team) to manage the property while you reap the rewards, you’ve found the right investment.

Passive investing in real estate syndications is much less hands-on than your typical residential real estate rental property, in fact, you’ll probably never see the property in person and won’t be involved in any day-to-day decisions.

You don’t have to be in contact with the broker, monitor the property manager, or receive and decipher between contractors’ bids. Instead, you get a few emails, sign a legal doc or two, and carry on with your life while the checks show up. As a passive investor, you’re a passenger on a plane ride. So, sit back and have a cocktail.

#3 You’re Looking for a Long-Term Investment

Maybe you’ve done your research and know not to look for some get-rich-quick scheme, but rather, are interested in a steady long-term approach to wealth. Unlike stocks or something you can flip in the two-year range, real estate syndications typically have a hold period for five or more years.

If you’re more of a set it and forget it type investor, and can plan for your investment capital to be unavailable for long periods of time, passively investing in real estate syndications may be your new obsession.

#4 Sharing Returns In Exchange for Less Work is Attractive to You

Fix-and-flips and standard rental property approaches to investing allow 100% of the profits in your pocket. Mostly because they are smaller deals, require plenty of sweat-equity, and often have only one party (you) financing and managing the deal.

Multifamily real estate syndications are completely different as there could be hundreds of individuals involved, thus some profit sharing. Usually, the passive investors get the larger portion of a 70/30 or 80/20 split, with the general partners getting the smaller percentage.

Group investments like this take a “team” or collaboration mentality versus a competitive mindset. The general partners are actively managing the property, making decisions toward renovations, and handling marketing and financial reporting. So, it only makes sense that they are rewarded for their efforts. If profit sharing and the concept of “a rising tide lifts all boats” makes sense to you, you’re in the right place.

#5 You Don’t Need the Money for a While

It’s possible you’re in a season of life where your kids’ vehicle purchases or college decisions are either several years in front of or behind you, that you’re in a home that doesn’t need a massive kitchen renovation, or just that you have spent some time planning well, establishing savings accounts, and minding your expenses.

If this is the case, you also likely met the criteria in #1, and you are going to be okay having your money “locked-up” for a bit. You’ve worked hard to save, budget, and build a little nest egg, and you’re just looking for somewhere to park it for a few years with the possibility of earning some interest.

Not needing your savings for the foreseeable future is a fantastic feeling, and if this describes you well, investing passively in a real estate syndication might pique your interest even more after realizing how well-positioned you are for this type of investment opportunity.

Recap

You’ll love being able to invest your money in real estate without the hassles of being a landlord all while having the chance to invest with different sponsors in different markets and different asset classes. Plus, the tax benefits (and sometimes even the returns) from passive investing can surpass those from personal rental properties.

But, being a passive investor isn’t for everyone. So, if you…

• Have more than $50k of “play” money
• Are okay NOT having an active role
• Are looking for a longer-term investment
• Find collaboration and sharing returns attractive
• Want to park your cash for 5+ years

…then investing passively in real estate syndications might be the best fit for you.

The beauty of real estate investing is that it’s so incredibly diverse. Perhaps some of the above doesn’t’ describe you and you want to roll up your sleeves and do the work yourself first to learn the ropes. Or perhaps you’re looking for a more liquid or a shorter-term investment. That’s okay.

There are so many opportunities out there to invest in great projects and impact local communities. Commercial real estate syndications are just one avenue, but if you meet a few of the criteria above, you might have found your match.

Once you decide to invest outside your local area, the possibilities are limitless. This can be exhilarating and overwhelming at the same time.

A tidal wave of thoughts may come flooding in immediately. Should you consider a bustling city or a metro area? You may reminisce about a vacation you enjoyed and the gorgeous buildings you saw there.

You could dive down every possible rabbit hole, cross-referencing “best real estate market” lists, trying to make sense of current population trends, and even looking up news local to areas you’d be interested in. Honestly, this won’t really help you draw any conclusions, plus you’ll waste a ton of time and energy.

Instead, begin by assessing your personal investing goals. Maybe you want to invest in a growing market that also provides decent cash flow. Using that basic framework, this research checklist will help narrow things down:

• Job Growth
• Population Growth
• Job Diversity
• Landlord/Tenant Laws
• Taxes
• Geographical Features
• Cost of Living
• Local News
• Local Government
• Whether You Have an Unfair Advantage

 

Job Growth

Since steady job growth is indicative of a healthy local economy that’s likely attractive to new businesses, developers, and residents to the area, this is the most important metric to evaluate in each market.

Job growth is a leading indicator of population growth. The more jobs, the more residents, the more likely the area will maintain a strong tenant base. When more people are attracted to an area, the demand for housing increases, which drives up rent and real estate prices.

Population Growth

Since the population in a certain area could be affected by natural disasters, migration patterns, and more, you always want to research it after job growth.

Finding an area with long-term upward population growth trends (not a temporary bump) is key, and a major factor supporting that trend is job growth in the area.

These two metrics provide a full picture of the health and future of a given market.

 

Job Diversity

You want to find an area with a variety of industries supporting the local economy. Strong job growth is much less enticing if you discover that most of the jobs in the area are, say, in the tourism industry.

A recession or a negative news story could largely impact the number of tourists, and therefore the job growth and the population trend. A diversified job market is much more attractive since a hiccup in any single industry likely wouldn’t affect the area as a whole.

 

Landlord/Tenant Laws

Beyond the top 3 factors – Job Growth, Population Growth, and Job Diversity, the next best factor to learn about has to do with the laws governing rental properties.

Rent control, for example, is great for tenants but makes it incredibly challenging for landlords to make a return on an investment in an area where costs for contractors, pest control, and property management are skyrocketing.

As an investor, you want some insight from local property managers who are intimately familiar with these laws, so you can find landlord-friendly areas.

 

Taxes

While usually the last thing on investors’ minds, taxes can make a huge difference on the bottom line.

State income taxes and property taxes will both impact your operating budget thus, your overall return. Each state has a different tax structure and it’s good to understand what you’d potentially be getting into so you won’t be surprised later.

 

Geographic Features

Use Google Maps to check out the actual, physical landscape of the area. Look for physical barriers like a body of water, a mountain range, or any other geographical features that could inhibit the physical development of the area.

As an example, coastal cities are limited by the ocean. Development can only get so close to the water, which forces them to build upward or expand into the suburbs. This drives up the value of centralized real estate, especially in a time of job and population growth.

 

Cost of Living

By seeking out an area where the cost of living is low, especially in comparison to the median income in the area, you’re more likely to experience growth. If people can afford to live in the area easily, there is room for the cost of living (i.e., rent) to rise as more jobs and people move into the area.

 

Local News

While the other, previously listed factors are much more important, once you’re pretty “sold” on a certain area, you may want to track a few local news stories.

It would be great to have some heads-up about new companies moving to (or away from) the area, local announcements, community developments, and anything else that would allow a sense of understanding of the local economy and potential future of that market.

 

Local Government

Just as with the local news, the local government is indicative of the area’s future standings. It’s a good idea to invest in areas with strong local leaders who support new initiatives, an expanding local economy, and who’s vision includes making the market vibrant and welcoming.

Strong leadership from the local government is attractive to corporations, which means that job growth will continue.

 

Whether You Have an Unfair Advantage

There’s always the chance that you have greater insight into a certain area, more so than other investors. Maybe you have a close cousin or best friend who lives there, maybe you went to college there, or you grew up there.

Any time you possess an unfair advantage, more weight should be given to that market. Local connections or a little history with a particular area can put you leaps and bounds ahead of other investors.

 

What About Investing Passively In a Real Estate Syndication?

As a passive investor, you’ll focus on finding a strong sponsor first. Once they let you know about potential deals, you can use these 10 factors, in combination with your personal criteria and goals, to conduct your own thorough research while avoiding overwhelm.

Any time a potential investor is reviewing real estate syndication investment opportunities, they’ll likely come across the term “equity multiple”. Even if they’ve purchased a primary home or a residential rental property before, it’s unlikely they’ve heard of equity multiples.

When it comes to passively investing in real estate syndications, however, it’s an important phrase to know and understand.

What “Equity Multiple” Means for Investors Interested in Real Estate Syndications

As a new or seasoned real estate investor, it’s important to know what you’re getting yourself into. Part of that awareness comes from understanding the metrics presented in the investment summary prior to agreeing to the deal.

As passive investors review potential real estate syndication deals, the term “equity multiple” might seem confusing or even daunting if no one’s ever explained what exactly that means.

Alternately, our investors have shared with us that, after they grasp the concept of equity multiples, they are able to more confidently compare projected returns and make wiser investment decisions.

Defining “Equity Multiple”

The initial amount invested into a deal is an investor’s capital. That capital equals the amount of equity an investor has in the passive investment. Thus, the term Equity Multiple simply means the amount your capital (or equity) will be multiplied by the end of the deal.

If a real estate syndication deal has an equity multiple of 2x and a projected hold time of 5 years, that means investors can expect to double their capital (original investment) in that 5 year period.

The equity multiple is the total of the cash flow distributions plus the returns after the sale of the asset.

A Little Math to Help Demonstrate

How about we explore an example deal with a 2x equity multiple?

The investment (capital, also referred to as equity) is $100,000 and this deal has a projected annual rate of return of 8% with a 5 year hold period. This means the investor may receive about $8,000 per year for 5 years.

In other words, over a 5 year period, the investor will have received a total of $40,000 in cash flow distributions. Then, when the asset is sold, investors receive their initial $100,000 back, plus another, say, $60,000 in profit from the sale.

When the $40,000 in cash flow distributions and the $60,000 from the sale are added up, that’s $100,000 in total returns. The investor began with $100,000 and, not only got that back but also earned an additional $100,000 cash.

In this example, the investor has doubled their money, which is what it means to have an equity multiple of 2x.

How Passive Investors Might Look at Equity Multiples

In real estate syndication deals, it’s actually quite reasonable to expect to double your investment over the course of 5 years, but that doesn’t mean these deals are easily found. Here at New Level Investments we aim to present our investors with a 2x equity multiplier over a 5 year hold period.

Remember, the equity multiple, just like any other projected return or rate, is projected. That means it’s estimated using formulas, algorithms, and expectations of the market, and it’s not guaranteed. The actual returns may be below the projections shown on the investment summary, or they may far exceed what was thought possible.

All in all, investors should be reviewing the details of any presented deal with a discerning eye and ask any and all questions that come to mind until they feel comfortable with the information presented and confident that they are ready to move forward.

Now that you fully understand equity multiples, you can approach the next deal with confidence around that term.

Imagine spotting an old bookshelf sitting out on the curb. You pull over to check it out, and since it’s in good shape, you proceed to lug it home and give it a fresh coat of paint.

A few years later, you sell the shelf to someone else who claims to have the perfect spot for it.

You took something that had been overlooked, committed some sweat equity, and breathed new life into it. This is the essence of value-add, and it’s a commonly used strategy in real estate investing.

The Basics of Value-Add Real Estate

In the case of single-family homes, the process of buying a run-down property, remodeling it, and then selling it for profit, is commonly referred to as fix-and-flip. Your sweat equity and ability to see a diamond in the rough is rewarded monetarily, and the new owner gets an updated, move-in ready home.

Value-add multifamily real estate deals follow a similar model, but on a massive scale. Hundreds of units get renovated over years at a time instead of just one single-family home over a few months.

A great value-add property may have peeling paint, outdated appliances, or overgrown landscaping, which all affect the curb appeal and the initial impression that a potential renter will form. Simple, cosmetic upgrades can attract more qualified renters and increase the income the property produces.

In value-add properties, improvements have two goals:

• To improve the unit and the community (positively impact tenants)
• To increase the bottom line (positively impact the investors)

Value-Add Examples

Common value-add renovations can include individual unit upgrades, such as:

• Fresh paint
• New cabinets
• New countertops
• New appliances
• New flooring
• Upgraded fixtures

In addition, adding value to exteriors and shared spaces often helps to increase the sense of community:

• Fresh paint on building exteriors
• New signage
• Landscaping
• Dog parks
• Gyms
• Pools
• Clubhouse
• Playgrounds
• Covered parking
• Shared spaces (BBQ pit, picnic area, etc.)

On top of all that, adding value can also take the form of increasing efficiencies:

• Green initiatives to decrease utility costs
• Shared cable and internet
• Reducing expenses

The Logistics of a Multifamily Value-Add

The basic fix-and-flip of single-family homes is pretty familiar to most people, but when it comes to hundreds of units at once, the renovation schedule and logistics aren’t as intuitive. Questions arise around how to renovate property while people are living there and how many units can be improved at a time.

When renovating a multifamily property, the vacant units are first. In a 100-unit complex, a 5% vacancy rate means there are five empty units, which is where renovations will begin.

Once those five units are complete and as each existing tenant’s lease comes due for renewal, they are offered the opportunity to move into a freshly renovated unit.  Usually, tenants are more than happy with the upgraded space and happy to pay a little extra.

Once tenants vacate their old units, renovations ensue, and the process continues to repeat until most or all of the units have been updated.

During this process, some tenants do move away, and it’s important for projects to account for a temporary increase in vacancy rates due to turnover and new leases.

Why We Love Investing in Value-Add Properties

When done well, value-add strategies benefit all parties involved. Through renovations, we provide tenants a more aesthetically pleasing property, with updated appliances and more attractive community space. By doing so, the property becomes more valuable, allowing higher rental rates and increased equity, which makes investors happy too.

The property-beautification process and the fact that renovated property is more attractive to tenants is probably straightforward. But let’s dive into why value-add investing is a great strategy for investors.

First, Yield Plays

 To fully appreciate value-add investments, we must first understand their counterparts, yield plays. In a yield play, investors buy a stabilized asset and hold it for potential future profits.

Yield play investments are where a currently-cash-flowing-property that’s in decent shape is purchased and held in hopes to sell it for profit, without doing much to improve it. Yield play investors hold property in anticipation of potential market increases, but there’s always the chance of experiencing a flat or down market instead.

In a yield play, everything is dependent upon the market.

Now, Let’s Get Back to Value-Adds

 Value plays and yield plays are the opposite. In a value-add investment, significant work (i.e., renovations) takes place to increase the value of the property and doing such improvements carry a significant level of risk.

However, value-add deals also come with a ton of potential upside since the investors hold all the cards. Through physical action steps that improve the property and increase its value, value-add investors don’t just hold the asset hoping for market increases.

Through property improvements, income is increased, thus also increasing the equity in the deal (remember, commercial properties are valued based on how much income they generate, not on comps, like single-family homes), which allows investors much more control over the investment than in a yield play.

Of course, a hybrid yield + value-add investment is ideal. This is where an asset gets improved as the market increases simultaneously. Investors have control over the value-add renovation portion and the market growth adds appreciation.

Now, before you get too giddy about the potential of a hybrid investment, there are risks associated with any value-add deal.

Examples of Risk in Value-Add Investments

 In multifamily value-add investments, common risks include:

• Not being able to achieve target rents
• More tenants moving out than expected
• Renovations running behind schedule
• Renovation costs exceeding initial estimates (which can be a big deal when you’re renovating hundreds of units)

 Risk Mitigation

When evaluating deals as potential investments, look for sponsors who have capital preservation of the forefront of the plan and who have a number of risk mitigation strategies in place. These may include:

• Conservative underwriting
• Proven business model (e.g., some units have already been upgraded and are achieving rent increases)
• Experienced team, particularly the project management team
• Multiple exit strategies
• The budget for renovations and capital expenditures is raised upfront, rather than through cash flow

Value-add investments can be powerful vehicles of wealth, but they also come with serious risks. This is why risk mitigation strategies are important – to protect investor capital at all costs.

Recap and Takeaways

No investment is risk-free. However, when something, despite its risks, provides great benefits to the community AND investors, it becomes quite attractive.

Properly leveraging investor capital in a value add investment allows drastic improvements in apartment communities, thereby creating a cleaner, safer places to live and making tenants happier.

Because investors have control over how and when renovations are executed, rather than relying solely on market appreciation, they have more options when it comes to safeguarding capital and maximizing returns.

Sounds like a win-win!