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— Multifamily Properties Quarterly — October 2015
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cross the Denver metro area,
apartment rental rates and
occupancy levels are hitting
record highs, which creates
an attractive environment
for landlords. By adding value to
properties now, landlords have the
opportunity to lock in the value of
their asset for future stability. What
are the best ways to add value in
this market? Following are three dif-
ferent methods investors can use to
accomplish just this.
1. Stabilize rent roll.
Effectively sta-
bilizing rent rolls can be the easiest
way to add value to your apartment
asset. However, it also may pres-
ent the risk of capitalization rate
compression. Some investors have
been purchasing properties and flip-
ping properties six to 12 months
later. Those decisions are based on
the market going up in value and
the capitalization rates decreasing.
The strategy is to turn over a rent
roll that may be 10 percent or more
under market averages and to bring
all of the rents to current market
rates.
By simply stabilizing the rent roll,
value is added. Interest rates remain
extremely low, thus allowing cap
rates to continue to drop. Cap rate
compression only can happen as
long as the delta between cap rate
and interest rate is high enough for
a yield. This strategy works great in
a market like Boulder where rents
never seem to decrease and occu-
pancy levels rarely dip.
When vacancies increase, rent lev-
els drop. When interest rates rise, the
scenario of relying on cap rate com-
pression quickly can go from an easy
way to increase
value to an asset
that potentially
could be upside-
down.
2. Perform moder-
ate asset rehab.
In this method
investors purchase
properties and
displace all of the
residents to rehab
the entire building.
Investors are drasti-
cally changing the
curb appeal with
new landscaping, painting, windows
and replacing all of the appliances,
cabinets, countertops, bathrooms,
flooring, lighting, and heating and
cooling systems. These investments
sometimes are upward of $25,000 to
$35,000 per unit.
Most of the time investors can
obtain 75 percent of the loan for
improvements, including the build-
ing’s purchase price. Some loans
allow for the debt service to be paid
out of the construction loan or defer
payments until completion. By doing
this property owners avoid carrying
a large mortgage payment during the
vacancy time period. This process
can take at least four to six months,
depending on construction sched-
ules and the time it takes to vacate
the building.
Many investors choose this path
because they like the finished prod-
uct and the acquired tenant base is
seemingly more desirable. Lending
institutions that prefer this type of
transaction are lending aggressively
in favor of the investor. This strat-
egy is desirable if the investor has
the resources and time to complete
the renovations. In some cases we
have seen this scenario achieve rent
increases of 50 to 100 percent com-
pared with the previous rents.
3. Renovate vacant units.
A third
approach to add value to an apart-
ment property is to renovate as
leases turn over. For this method,
investors are purchasing properties
where some of the leases run month
to month. Tenants are given a notice
that their rent will be increased to
the market rate. We have seen a
surprising number of tenants agree
to pay the rent increase as a result
of the slim inventory of affordable
alternatives.
Alternatively, the units that are
vacated are modestly upgraded
with a slight increase of finish qual-
ity like faux hardwood floors, new
cabinet faces, new appliances, fresh
paint and carpet, or new vanities
and updated lighting fixtures. Most
investors who pursue this method
try to achieve a 20 to 30 percent rent
increase as opposed to top-of-the-
market rental rates. They do this in
order to avoid competing with new
product or properties that have been
completely renovated.
As a landlord, your profitability
relies on tenant quality; however,
turning tenant quality over is a sig-
nificant hurdle to overcome. A new
tenant paying a higher rent expects
quality amenities and cultural nice-
ties more than the previous lower-
paying tenant. This type of renova-
tion typically is a great strategy to
achieve improved tenant quality.
The downside is that it could take
10 months to a year to achieve the
anticipated value. This approach
may not be as cost-effective as the
overall savings an investor would
obtain with a full renovation, but the
investor appeal is that the property
can service debt and maintain cash
flow while increasing the property
value.
Aside from these three approaches,
there are other ways to add value
that investors may pursue, such as
decreasing expenses or correcting
management inefficiencies. However,
if you are a new or seasoned investor
who is planning for a change in the
business cycle, the past tells us that
in a market downturn, the properties
that were well maintained are the
properties that escaped the negative
effects of the market.
s
Ryan Floyd
Senior vice
president of sales,
Unique Properties,
Denver
Investment Market
This strategy works
great in a market
like Boulder where
rents never seem
to decrease and
occupancy levels
rarely dip.
