How to Add Value to Commercial Real Estate
Many of the readers of this blog are multifamily investors or hope to be someday. While multifamily investing has many positives to it, it is not the only asset class in commercial real estate. Additionally, in this blog, I discussed the different risk profiles of real estate, and these risk profiles exist in all real estate asset types. Today, I am going to be discussing what the value-add business plan generally looks like in the various asset types.
At a very high level, the value-add business plan is any business plan that, with minimal capital spent, the operator is able to increase the net operating income of the asset. These assets will be cash flow positive from day one but have room to grow that cash flow.
The value-add multifamily business plan is often one of light renovation. The previous owners did not choose to spend the capital to keep the property current to tenants. Therefore, it feels aged and cannot achieve full market rent.
The value-add operator is buying the asset with capital allocated to renovate the units and exterior of the property, but typically in a very cosmetic way. New cabinets, backsplash, counters, flooring, and fresh paint make up the common upgrade list. The operator is doing the HGTV treatment to the units. From time to time, the scope may be a little more intense, but any work is still limited to a single unit at a time, and construction timelines are typically less than two weeks of downtime. Once the units are renovated, the operator anticipates achieving a higher rent per unit.
There are variations to this plan, but the light, cosmetic upgrades plan is the most common.
Often times the value-add retail business plan has to do with modest levels of vacancy. The value comes from filling the vacant units and renewing near-term lease expirations. The vacancy is not so high that it creates a challenging retail environment and will typically sit in the 10-15% range.
Because retail leases tend to be much longer than apartment leases (five to 10 years versus 12 months) even below-market rents are hard to overcome, as the operator is bound to the leases present with the property. But, a focus on tenant mix is important for a successful retail center.
Like multifamily, there are often some deferred maintenance and capital items that need to be addressed. The focus of capital improvements is on the common areas. Common practices include restriping parking lots, installing better lighting, and dressing up pylon signage.
Similar to retail, the office lease is longer in the term, so the business plan comes down to filling vacancies and renewing near-term lease expirations. While tenant mix is not quite as pressing of an issue when compared to retail, office properties, particularly large office buildings, can benefit from a strong tenant mix. Most properties will have their anchor tenant, and ancillary businesses to that anchor certainly assist in leasing efforts and overall demand.
Once you get into capital improvement, the focus is comparable to retail. Common areas take precedent, with upgraded lobbies and elevators. Other common practices are adding amenities for the office workers, like a café and fitness facility on site.
Value-add industrial properties tend to stem from leasing efforts and below-market rents. For large projects, filling vacancies is the most common focus on value-add projects. When it comes to capital, the drivers of where to spend capital come down to renter demands.
Clear heights have grown in recent years. So a low clear height that might be fairly inexpensive to increase is a great option, but this renovation is typically not financially feasible. Improving access, parking lot capacity for more trailer storage, and adding technology to the property to aid in the movement and storage of products can help leasing efforts and increase value.
Hotel and hospitality properties look most similar to multifamily. Due to the management-intensive nature of hotels, the most common value-add play is to seek out under-managed properties and improve operating efficiencies.
Hotels are primarily a franchise business, with Hilton, Marriot, and Intercontinental owning a majority of the common flags you see. Because of this arrangement, there are capital improvement components to the value-add play, especially if the existing franchisee does not have the capital to renovate their brand to current brand standards. This would result in the existing owner either needing to sell, downgrade their brand within the franchisee structure or lose the franchise entirely. As such, a value-add investor could acquire the operating hotel and begin the renovations to bring the property up to current franchise standards for that brand and thereby keep a higher income stream.
As you can see, every asset class has its own nuances of the value-add business plan, but at the end of the day it boils down to the same thing. Spend money to take an outdated asset and bring it back to what is currently in demand, thereby increasing the overall income of the asset and the value.
About the author:
Evan is the Investor Relations Consultant for Ashcroft Capital. As such, he spends his days working with investors to better understand their investment goals and background. With over 13 years in real estate, he has seen all sides of real estate from acquisitions, to capital raising on the equity and debt side, to operations, and actively invests himself. Please feel free to connect with Evan here.
Disclaimer: The views and opinions expressed in this blog post are provided for informational purposes only, and should not be construed as an offer to buy or sell any securities or to make or consider any investment or course of action.