Monday, July 17, 2023

What Is Value-Add Real Estate Investing?

Also referred to as value-oriented real estate investing, value-add real estate investing is a commercial real estate (CRE) investing strategy that involves an investor purchasing a commercial property with existing income but requiring physical and operational improvements to tap into its full income potential. The income-generating potential of most CRE is the determinant of the property’s value.

Thus, by increasing its net operating income (NOI), investors increase its valuation too. After they achieve this, they can go in several directions, including refinancing the property, taking out equity from the higher-valued property, keeping it for a long-term hold, or exiting the deal via a disposition. Whichever option investors choose, both they and the owners capture the equity built via the improved property value.

Value-add real estate is one of the four real estate investing strategies CRE investors can pursue, along with core properties, core-plus properties, and opportunistic real estate. Each comes with a different level of risk and earning potential.

Core properties are usually well-established premium properties at premium locations with quality, long-term tenants. They entail the lowest risk and lowest but steadiest returns. Next come core-plus properties, which are also top-quality stable assets at attractive locations. They are slightly riskier than their core counterparts but can bring higher returns with minor physical improvements, tenant repositioning, and existing cash flow stabilization.

Value-add real estate can involve more considerable improvements, such as market repositioning and redevelopment. Thus, it is even higher on the risk spectrum but provides investors with greater capital growth potential and bigger returns. Opportunistic real estate is the riskiest strategy with the highest returns potential. Most often, these include land acquisitions, ground-up developments, and property conversions.

When looking for a suitable value-add property, CRE investors should consider characteristics such as below-market rents, low economic occupancy (how many people pay rent) and occupancy rates, physically obsolete exterior and interior, and poor property management.

When selecting ways to increase a property value, value-add real estate investors should make several important considerations. The primary one is the property’s positioning in the local market and its competitive power for tenant acquisition compared to similar properties in the vicinity. Others include identifying the main drivers of the property’s NOI and areas of improvement. Some examples of value-add real estate improvements are changing the property management company, upgrading the interior and exterior, and repositioning or rebranding the property.

Depending on the amount of work and capital investment a property requires to increase its value, value-add real estate can fall into three categories: light, medium, and high value-add.

Light value-add usually involves performing any deferred maintenance and affordable physical improvements. It requires minor capital investments but significantly improves the property’s look both inside and out. Light value-add interior improvements may encompass repainting units; replacing electrical, lighting, and plumbing fixtures; and adding new furniture and carpets. Among the exterior enhancements are refreshing painting, re-striping parking lots, renovating amenities, and upgrading the landscape.

Medium value-add improvements build on their light value-add counterparts and include more costly enhancements, such as complete renovation of bathrooms, kitchens, and roofs, as well as replacement of heating, ventilation, and air-conditioning systems. For many successful CRE investors, medium value-add real estate yields the best return on investment.

Finally, heavy value-add improvements include both light and medium value-add upgrades but may also involve sweeping renovations. Examples include adding or removing adjacent buildings and investing in new luxury amenities such as community centers, rooftop decks, and swimming pools.



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