What Is Value-add Real Estate Investing?
As you may know, Jonathan and I focus on value-add real estate deals. Value-add is real estate investor speak for simply buying a property where there is room for the asset’s value to increase, then executing the plan to make that happen. Once the asset’s value is forced higher, the property can be kept with significant equity and usually great cash flow, or the property can be refinanced or sold to use that new equity to repeat the value-add process with a different asset.
What creates value in commercial real estate?
Commercial properties are sold on a multiple of their net operating income, which is just the income of the property minus any expenses for the property not related to debt. In other words, it’s the net cash flow of the property without considering any payments for mortgages or loans on the property.
A simple way to increase the value of an asset (simple should not to be confused with “easy” here) is to increase the income the property brings in or to decrease the expenses. Either of those increases the net operating income, and therefore the value of an asset. Typically driving up the income is easier than reducing expenses.
Where Are These Value-Add Deals?
One type of opportunity we look for is properties where rents are well below market. By purchasing a property based on the income it’s currently bringing in, and then significantly increasing that income through bringing rents to market, the value of the asset increases accordingly.
The most challenging piece of value-add deals in today’s market is finding properties where the rents are under the market and where those assets are priced accordingly.
Often brokers and owners will price properties based on market rents even if the asset isn’t bringing in market rents, therefore giving the seller the value for the work and risk the new buyer would take on. These are the types of properties that get X’d out of our potential deal funnel.
Example Full Cycle Value-Add Deal
- Purchased a small mobile home community for $110k in 2021. It was an 8-lot community with 4 filled lots + 4 empty lots. The property was bringing in a total of $900/month.
- Spent $78k between closing costs, improving the property, & infilling the 4 empty lots with homes.
- Increased rents of existing residents over the 2-year period + added 4 homes to the 4 vacant lots. The total income increased to $2350/month, or 2.6x where it was when we purchased the property.
- Generated income during the hold period by selling the 4 homes we brought in to new residents + monthly cash flow. Around $50k total during the hold.
- Sold the property in Dec 2023 for $300k.
As always, I love talking about this stuff. Please reach out if you have any questions. [email protected] and if you’re looking for ways to put your money to work passively, make sure you join our Capital Club.