What is a “VALUE ADD” and what makes it a big deal?
A “Value Add” is just what the name implies, it is a scenario where we can add value to the price and value of the property. How do we do that you may ask? We can do it in a variety of ways. But in this discussion, let’s talk about adding value as it related to apartment buildings.
When you increase the income (or what we call the net operating income or NOI) in commercial real estate you increase the price value of the property. But this is not something to take lightly. When you increase the income of the property just a small amount, you increase the value of the property EXPONETIALLY!
Let’s look at the formula for price or value
NOI/CAP RATE=Value
Taking this formula, lets plug in some numbers and calculate a value.
Let’s assume 100 units @ $500/month in rents equals $600,000 per year in rents
Lets also assume 50% expenses equals $300,000 in “Net Operating Income” (NOI)
Let’s assume an 8% cap rate equals $ 3,750,000 in value (price)
So the above example is how the price is determined for apartments….
So the way to increase value is by increasing NOI or reducing your expenses…..or both!
Lets’ see what happens if you are able to raise the rent’s only $35 per month on each unit and you are able to reduce the expenses 5% from 50% to 45%…The change in value is surprising from just a little change like this….Look at the formula below…..By doing these small changes in rents and expenses, NOI increases to $353,100 multiplied by a .08 cap rate equals $ 4,413,750!! in value . That is a huge change in price from only raising rents $35 per month!
$353,100 NOI/ .08 cap = $4,413,750 (value/price)
The reason all this is important is because this is the type of project we try to find. We like to call them “Stabilized Value Adds” where the property is running ok but the rents aren’t quite up to market and the expenses need some fine tuning……All things that are very achievable to do with the right team in place.
Stabilized value add deals are out there, you just have to look for them. It is a common scenario where the property just isn’t being managed properly and needs someone to pay closer attention to the operations. When you do that, you can see how radically it affects the price of the property. And that is where an investor can get the best bang for the buck. By partnering with an organization who can optimize a property by paying closer attention to the small details….That’s what are specialty is…We like to hire the best management companies who are experts in operations….And we keep a close eye on them! 🙂
This is just a quick example of a “Value Add” deal…I hope this helps clarify where the profits can come from when investing apartments. If you have further questions about this I am happy to discuss with you.
let’s also talk about what is currently on the horizon and how it might fit into your portfolio…
Give us a call at 510-86-1447 if you have further questions about “value add” apartments.
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