The words “value add” shows up a few places on our website and if you search for “value add multifamily” on the internet, you’ll get dozens of articles and companies investing in or selling real estate. What is a “value add” project? In simple terms, we take an existing building and “add value” to it by improving the property.
However, that in itself doesn’t actually move the bar since what really matters is how the property is valued by others (i.e. banks and ultimately a new future buyer).
In typical residential real estate, the value of that property is based on what other similar types of properties near you have sold for and are expected to sell for today, known as “comparables” or “comps”. So, if you live in a neighborhood of similar houses with similar sizes, they would be expected to be worth about the same.
However, in the commercial world, the valuation of a property is heavily dependent on the income it generates, also known as its net operating income (NOI), which is the same term for the bottom line profit in an operating business (since commercial real estate IS essentially an operating business you are buying!). The combination of the NOI and a market “Cap Rate” are used to determine the price of an asset. This is why two buildings next to each other could sell for 2x the price of the other one if one generated significantly higher income.
Since the net operating income of a property is in our control (you can renovate units that will command a higher rent, reduce utility expenses by becoming more energy efficient, or do a myriad of other things that either increase top line revenue or decrease costs. This results in positive changes in the net operating income of the building). Therefore, through your own efforts, you can “force” appreciation in the value of the property by increasing your profitability (i.e. a higher NOI)
The last piece to this puzzle is to know the market “Cap Rate”, which is a proxy for valuing similar assets in a given area (i.e. Class A multifamily in the greater Atlanta area). Once you know the Cap Rate (most large brokers can run reports to estimate this for you or you can research on your own), you can then estimate the potential increase in value based on the improvements you make in NOI.
For example:
DW Capital buys a property for $2,000,000 that generates $100k per year:
- Cap Rate = NOI / Price
- Cap Rate = 100,000 / 2,000,000
- Cap Rate = 0.05 (5%)
Through our value add program, we renovate kitchens and bathrooms, and rebrand and re-lease the apartment at higher market rates. This raises our NOI by 20% yielding 120k per year instead of the prior 100,000 when we bought it.
- New Price = NOI / Cap Rate
- New Price = 120,000 / 0.05
- New Price = 2,400,000
… and that’s how we add value and generate returns for investors.
