You're listening to the Master Passive Income Podcast Network.

Hey, guys.

Welcome to the Master Passive Income Multifamily Podcast.

Charles Seaman here with Erica McNew.

And today we're going to be talking all about value added strategies.

And if you'd like our commercial Real Estate success guide, you can text the word freedom to 3, 3, 777.

Welcome to the Master Passive Income Multifamily Podcast where we guide you to invest in commercial real estate with a special.

Focus on raising money from others to buy bigger and better deals.

And now, here are your hosts, Charles.

Seaman and Erica McNew.

Erica, do you want to start us off with value add strategy?

Why don't we do a high level and talk about what value add is for anybody who's brand new?

Absolutely.

So value add is kind of like the equivalent, I would say, to fix and flip on the residential side.

It's where you are going in.

You're purchasing a multifamily asset and you are going to improve, whether it be the interior or exterior condition of the property.

It could include renovations.

It also includes improving the operational side of the property.

So working with the tenants, making sure everything is leased up at a higher rate.

Is there any market rent bumps that can happen?

And we'll get into that.

So it's going in and basically improving an overall property, which therefore improves the net operating income, which therefore improves the value of the property.

Total has become very popular in recent years.

You'll hear a lot of investors focus on that strategy.

So let's start at the beginning.

So what's the first part of that process and what do people need to do?

So?

Well, first thing is you have to identify an underperforming property.

One of my personal favorites is identifying property that there is a potential rent bump for.

So if you know, on properties right now, for instance, if I can find something that has, you know, a 2 to $300 rent bump, that's great.

That is a great opportunity, potentially, that one.

That's definitely one we want to look at further with the financials.

I know of a property in Florida where the seller was just very retired, basically from value adding, any operationals.

And a rent bump on that property was as much as $500 per door, which is just insane.

So the rent bump is one of my favorite ways to identify an opportunity, a potential opportunity.

And then how about you?

What do you think, Charles?

Well, underperforming can mean different things to different people, right.

Sometimes it's a property that's in disrepair, sometimes it's A property that's mismanaged.

Sometimes it's a property, as you said, with an owner who's very hands off and maybe for different reasons.

They're just in a position where they don't need to be putting a lot of time or effort into the property, and it shows.

And because of that, you know, there's an opportunity for an incoming buyer to go there and increase the value.

One very important part when we're talking about value add, and this probably doesn't get talked about enough in the industry, when you're buying value add, you have to buy it at a discount.

If you go in there and you're overpaying for value add, then you're no longer value adding because you've shot the strategy in the foot on the front end.

Yeah, I see that happen a lot as well.

Very much so.

And you can't pay for pro forma value add.

Right.

You can't say, okay, the property should increase by this much.

Should we do our job.

And the seller's getting a premium for that for some reason, so.

Absolutely agree.

It's a very common mistake that I think we see.

Well, there's a couple of things that you touched on.

So the first one you mentioned was renovation, potentially going into a property that might need some improvement.

So that's a pretty popular value strategy.

Right.

So a lot of people use that.

They like updating the units with modern finishes.

So one thing I always look at, you know, with any property in our society, styles change.

Right?

Right.

So as a woman, you could probably speak better this than I could because I'm probably not as in tune with some of these things.

But would you agree that styles change fairly frequently?

I absolutely know of a property with some green carpets in it right now.

I don't think those are too popular these days.

Yeah, I have to admit I haven't seen those too much in the last 40 years, but probably a little bit dated, but definitely could be an opportunity there.

You're right.

Some people don't like green coin nowadays.

It's strange.

So one thing a lot of people do when they go in these properties is they're doing more cosmetic updates.

And the reason you're doing that is because it's what people can see when people are coming in to rent the unit.

They're not taking the opportunity to open the walls and see what the wiring or the piping looks like, but they're looking at the cabinetry, they're looking at the countertops, and they're looking at the flooring and you know, a lot of times when you bring prospective tenants in there, those are the things that are going to cast their eyes.

So a lot of people in our space spend money on these items to go in there and improve these items, and they're going to put money in beautifying the unit.

So that way somebody walks in and kind of has that wow factor and it sells them on it without having to do a whole lot of work.

So sometimes that can come with a rent bump, and you can set your budget accordingly based on where, you know, where that rent bump is.

What else can it do aside from just the rent bump?

So when you upgrade units, are there any other benefits that you see, Erica?

Happier tenants, which is always a really good thing.

Less work orders, less maintenance, repairs, which is always a really good thing.

Absolutely.

And just noting on this one, this could also include adding amenities to the property.

So each type of amenity that you can add to a multifamily property will typically net you an average price per door with that amenity add.

So it depends, but that could be anything from fitness centers, a clubhouse, a laundry facility, which then can be an additional revenue source on that property.

Pet areas are getting more and more popular, so it also could include amenities and construction on those types of things as well.

Totally could.

And, you know, most 60s, 70s, and 80s properties weren't built with a lot of amenities in mind, so there's definitely room to improve on some of those things.

You know, as Erica mentioned, you have a lot of.

You have a lot of single people renting units nowadays that like pet areas, they like having dog parks, they like having, you know, pet spots, all different things.

So that helps you attract a tenant demographic.

You know, some people like to go in there, they like to have community feel, so they like having a swimming pool, they like having a gaming area, they like having somewhere they can go there and congregate and get to know the neighbors and hang out.

So by creating these spaces and these amenities throughout the community, you're able to attract a different demographic sometimes and oftentimes improve the demographic if that's reflecting what they want.

I think one of these here near uptown Charlotte even has like a little mini bowling alley in it, which is so cool.

So you'll.

And then I've seen like mini golf courses, so you'll see some pretty neat things on the quote unquote, luxury apartments that are going in.

Yes, you definitely.

It might just be me, but personally, when I walk by and I happen to see one that has like one of those giant like checkerboards outside.

I always enjoy that.

Absolutely.

Good value add.

Connect four, actually.

Not checkers.

I apologize.

Right.

Well, it's the chess games, the life size chess games.

Those can be cool.

Yeah.

And the truth is they're netting a higher rental rate than maybe some of the neighboring competitors because of the addition of amenities they've chosen to put in.

So it can ROI for sure.

So renovation is only one way, but it's certainly not the only way.

So there's also operational efficiencies.

For me personally, this is my favorite way.

There's a lot more risk whenever you're upgrading something, because if you're upgrading something, you're taking the risk that you're spending a certain amount of money to get that return.

Now that's great if you're right on the return, but what if you're wrong?

Then you have a lot more risk and you didn't wind up getting that rent bump that you thought.

So.

Operational efficiencies can allow you to improve the property's financial performance without spending a ton of money.

So that can be a plus.

What is an operational efficiency?

So let's talk about that.

So somebody who's, who's brand new.

Erica, what would, what would be an.

Example of an efficiency, operational efficiency would be being able to build back utilities.

That can be an additional value add opportunity.

We have optimizing maintenance expenses and again that can just be from maybe going in and doing the construction.

And now you have less maintenance expenses and work orders, property management expenses.

Optimizing that is something that I see people do quite often.

And it could also be something that works against you in your acquisition where you have to make sure to mitigate adding in a property managed expense where maybe it was being self managed.

So but looking at those types of things and where you can value out on each line item and being very detailed on going through each line item, I think is important on your due diligence.

What about you, what about your experience, Charles?

Well, you know, one of the things I think that's a plus, especially as you start to gain more properties in the same area and you scale is that's when you start seeing the benefit of those economies of scale.

And like having one property in an area, you may not get that much of a discount in comparison to a smaller property.

But having multiple properties and being able to share staff and being able to share resources, all of a sudden you notice your dollars go a lot further once that happens.

Because let's say if you don't have enough work for the staff at one property, but you don't really want to lay them off because you know that would be counterproductive.

Maybe you send them to a different property in the area where there's work and all of a sudden now you're sharing maintenance personnel or leasing personnel and you're able to keep some costs down by doing that.

So those are things that can be operational efficiencies.

Sometimes it can be realizing that the current owner is just spending way too much money on certain things.

You know, maybe they're vendoring out things they could be doing in house.

You know, one thing that one of my property management contacts always said, and I kind of agree with him on this, you know, he would always talk to the maintenance guys at the properties and say, look, if I have to hire a vendor, what do I need you for?

And that's a great philosophy because you know what, if I'm calling vendors for everything, then I don't need to be paying you a salary as well.

So that's an efficiency.

So you want to get more productivity out of those payroll dollars and get as much as you can for them.

So that way you're not using third party vendors only when needed and that helps you keep cost down.

So be aware of that.

Another thing is having a management company or an O ship team that's keeping an eye on where things are going at the property.

One of my partners has a property in his portfolio where, you know, he didn't know this at the time, but he thinks it now in retrospect that one of the former managers was probably siphoning appliances and using them for other things.

Because he would always say, like, why is the bill so high?

Now he got rid of that manager and he noticed that there's not as many appliances being purchased.

So things like that, you know, it's amazing how things can get up and walk away.

So you got to have people keeping an eye on these things and you got to have some type of checks and balances in place to be able to know what you're buying, where it's going and what you have.

Absolutely.

And I would say too, it's also little things like you could also have technology efficiencies that are added in, right?

So the property management software, the smart homes, so you have the thermostats, the smart home thermostats, you have the keyless entry.

Now you've eliminated all this need for keys upon people, you know, with their welcome packets.

So like the logistics too of the operational side, there's A lot there and that can be added there.

So.

And that also makes for happier tenants, which hopefully adds up to stability of the asset, less vacancy rates and potentially even higher rent rates.

So all very good stuff.

Well, let's talk about repositioning the property.

So there's really two parts of this, Erica.

Right.

So you got the property itself and you got the area.

When the area is being repositioned, is that something that we can control as an owner?

Not.

Not really, no.

Not in my opinion.

I do think that you can have very friendly relationships with your city councilman, your city managers, your planning department.

You can know where your assets are located and make sure that you are super in tune with the people that are in charge of the infrastructure changes in that area.

I think that's one thing that you can do, your chamber of commerce rate and those kind of things.

So I think there are ways to be involved with what's happening as far as the market changes and infrastructure changes around your asset, for sure.

But you're not in maybe direct control of it, right?

Right.

Yeah, it's very rare.

You can never really be in direct control that unless you have enough.

Enough clout behind you to go there and buy all the properties in the area.

Most people don't have that type of cloud, but what you can do is you can capitalize on it.

Right.

So if the area is already starting to gentrify and you can see that there's clear evidence that this is happening, maybe you go in there and you reposition your property to reflect that change in the area.

Sometimes you can just capitalize on it.

You know, I bought a property in an upcoming area of Charlotte.

It's actually in an opportunity zone, but it's an area that has a lot of development.

But it's also that historically has been very rough because keep in mind that gentrification doesn't happen overnight.

It's not going to be six months or 12 months down the line.

It's something that may take a decade because they have to totally transition the area.

But as you see new development and you see new businesses opening that are bringing new jobs to the area, eventually that change will come.

So we had bought a property in early 2021 in a gentrifying part of Charlotte.

And there were two things we liked a lot that really encouraged us to buy the property.

One is that literally right next to the property we bought there was 148 unit townhome community under construction.

Second thing is the city had announced plans to build a train line that was Going to run right through that area.

So when you see the government spending money to lay tracks and to build a train line, and you see private developers going in there and building new communities, that's usually a good sign that property values are going to go up in the area.

So we took advantage of that.

We decided to buy the property because we knew the area was rough, but we also saw the improvement coming.

And because of that, we actually sold that property earlier this year.

We were able to do pretty well with it because it had a lot of upside potential.

As the area kept improving, there's still more development that's happening now.

So in the next couple of years, it will probably be worth even more as the area continues to improve.

Making sure you're buying in areas where you can ride that wave, that's going to go a long way.

Did you rebrand it to a luxury apartment?

You know, that's a joke.

So one of the keys that's often talked about and evaluated is leaving meat on the bone for the next buyer.

So that was meat on the bone for the next buyer.

You know, our goal was to put a minimal amount of capex into that one.

Realizing that the area wasn't there just yet and capitalizing on the expected future growth in the area based on what we already saw.

And, you know, that was kind of something we left for an incoming buyer to say, okay, put that on the hook so they have something to be excited about.

Yeah, absolutely.

That rebranding, though.

Rebranding is another aspect of repositioning the property for sure.

Whether that be taking over a failing property where the owner or manager is just letting it completely fail and the tenants are unhappy, vacancy rates are going up and going in there and rebranding it, whether it be the name, the logo, you know, going after the reviews and getting the reviews back up, so whatever that looks like.

Also, there's value add, opportunity and rebranding because it is essentially a business that you're buying with multifamily.

So you essentially are rebranding the business of that building.

So that is another, I think, key component of it, for sure.

Absolutely.

And rebranding can be done for a lot of reasons.

Right.

Sometimes you want a fresh start, you know, so sometimes you buy a property, maybe the online reviews aren't good.

You can go there and spend months and years trying to improve those online reviews, or you can just whitewash it out again and give it a new name and a new facelift and.

And build the reviews from scratch.

Or sometimes that's the easier Approach.

Sometimes it could be because the group just wants to put their name or their brand on it.

There's a lot of groups who buy properties.

They put whatever the name of their group or their brand is in that, that name.

And that lets people know, oh, this is one of their properties.

And hopefully if that group has a good reputation, then the good reputation that people associate with that brand will be associated with that property now by every time they pass by it.

Absolutely.

So then you got financial analysis and budgeting.

So with a lot of things in business, you know, it's beneficial to a cost benefit analysis, right?

So you want to understand how much something is costing you and basically how much bang for your buck you're getting out of it.

So you want to prioritize your projects that are giving you the highest return on investment.

So let's use an example, right?

So let's say you go out there and you say you're going to put $5,000 into a unit and that $5,000 is going to get you a, you know, a $75 rent pump each month.

Or you have an option of putting $3,000 in and that $3,000 is going to get you 60, 60 bucks a month at a rent bump.

So technically the 75 bucks is obviously greater than the 60 bucks, but is it really worth that extra $2,000?

And the answer is no.

You're actually getting a better return by spending less money.

So depending on the property and the area, the demographic you're catering to, it could be kind of a ceiling with some of these thresholds.

And you want to understand what people are willing to pay for a particular product in the area and gauge your spending decisions accordingly with that.

Absolutely, I agree.

I think that it's one element to go in and do the construction value add of like just, even if it's light cosmetic interior construction, with the other side of that is the budgeting of that project for sure and ensuring that the contractors are in line with market rates or better and that you are making sure their material costs are not going up too high.

And you're truly measuring all of that.

And one of the ways to mitigate that is making sure you have the right contracts in place with them.

So really, you know, I like the model of like they charge you what is the work going to cost?

And it's in the contract that there's no, no additional invoices or worker orders outside of this quoted amount.

And that keeps them self accountable to staying within budget.

So there's different ways to mitigate it for you as the general partner on that asset of how much you have to oversee these things.

But the budgeting of that construction as it moves along is critical because you can get off track and you're going to get off track at scale and then it compounds very quickly.

So budgeting of everything, especially the construction side, I see that being pretty important.

Yeah, budgeting is definitely key.

Well, let's talk about now once somebody does all these things.

So let's say they've identified the property, they bought it, they've done some upgrades, they've got some operational efficiencies, maybe they've rebranded it.

So let's talk about the exit strategies.

What options do people have there?

Well, there's full sale, right.

You just, you value added to the property and you're prepared then for a sale.

That's I think one of the ones that is most common and really that's you have a pre written exit strategy on that property.

I always believe in plan A, B and C.

However, you've gotten to a point on your hold period where you've accomplished the strategy or whatever returns you were solving for, you accomplished it and now you're going to go ahead and sail.

One of the cons of the sale is that, you know, one of the points of real estate is to help mitigate taxes.

So if you have a large capital gain tax on that property, that's part of the reason that maybe somebody would choose to refinance on that deal and refinance into the next one instead.

Totally.

So definitely a sale and refinance, two very popular, very common options.

And another option could be just simply holding the property.

Right.

So if the property is performing, maybe you're happy with the cash flow and maybe you just want to keep it for the long term and have an ongoing income stream.

So that could be another possibility as well.

Absolutely.

And then obviously if you're, you know, you're, you're.

I'm always encouraging that if you're going to do a sale and you do have a significant capital gains tax that you're looking at for you and your investors that you would consider a 1031 exchange.

That's I think what a lot of people will do on these types of assets and then 1031 maybe into the next project.

So different exit strategies.

I think we've also talked about a little bit.

I saw one that could be converted to condo on the exit strategy, which obviously there's a lot to do there as far as paperwork and making sure you have all the right documentation to create the condo, you also have to get it approved by the lender.

But it is an exit strategy.

I've seen on people's offering memorandums.

Yeah, if you're coming into a strong market, a condo conversion can definitely be an option.

And obviously you have to be in a, you know, property that has the zoning for that as well.

But if you have all those pieces fall into place, you know, and you have good market conditions, that could be potentially a very lucrative one.

I mean, in 2007, 2008, a general partner told me not long ago that that's was one of the main strategies in Florida for multifamily properties to get out of what they were going through.

A lot of the banks allowed them to go ahead and convert to condos, and that was one of the main strategies they used.

So it shows it can be very profitable indeed and potentially even get you out of a bad situation if it is an option.

Totally.

Well, guys, we want to thank everybody for joining us for this episode of the Master Passive Income Multifamily podcast.

Once again, if you want our commercial real estate success guide, text the word freedom to 33777 until next time.

Thanks, guys.