Buying an older apartment building in need of a few upgrades could be your ticket to a pay raise. According to the National Real Estate Investor, it’s still possible to find older multi-families in areas with strong or growing rental demand that only need minor renovations to charge higher rents. One consultant told the NREI, these “value-add” investments are “still a viable investment strategy at this point in the cycle.” (1)
Value-add real estate investing applies to any strategy that capitalizes on the need for operational or physical improvements to a property, and by purchasing these properties and performing the upgrades, can justify higher rent levels. Combine that with a strong demand for rentals because homeownership is so expensive right now, and you have a winning combination for any kind of property.
You typically need more money to buy a multi-family than a single-family rental. But, if you are a first-time homebuyer or you haven’t owned a property for more than three years, buying a multi-family property can be quite inexpensive with an FHA loan.
A friend of a friend just purchased an older four-plex in Henderson, Nevada, outside of Las Vegas for $400,000 with an FHA loan. He only needed to cough up 3.5% of that amount for a down payment, which is just $14,000. That left him with some cash to make improvements to the four units. Once the upgrades are done, he can charge more for rent. Comps show that rents for similar units in the same neighborhood but with more upgrades are substantially higher. The other requirement is owner-occupancy, in one of the units, but he doesn’t have to live there forever — only for 12 months.
Even if you don’t qualify for an FHA loan, finding a value-add property like this one can be lucrative. As the NREI points out, if you charge more rent for these older, but upgraded apartments, they will still be in high demand because the rent will be lower than units in a brand-new building.
Workforce Housing Needed
That’s one reason this strategy works so well right now. Workforce housing is in high demand, and because of housing affordability issues, would-be buyers are left with no option but to rent. A recently released report from the Census Bureau shows, rental demand is surging and apartments are renting out at the fastest rate in three years. John Pawlowski, of Green Street Advisors, said in a CNBC blog, “People underestimate how far away from homeownership a lot of renters are.” (2)
Value-add properties also compete well against luxury rentals that many tenants can’t afford. The rents will be lower than brand-new apartments, but as neighborhoods gentrify, there’s more upside to those rent levels.
This isn’t a new concept. According to Real Capital Analytics or RCA, value-add investment has been a hot strategy for several years. The research firm says that in the 12 months that ended last September, investors spent $31.9 billion on value-add apartment properties.
Value-Add vs. New Construction
Although rental demand remains strong, the NREI says, the market is getting more difficult for new apartment buildings. It says, developers opening new buildings in expensive urban centers can’t expect much rent growth. Rent growth in 2019 is only expected to average 2.5% in the coming year. Developers are also offering expensive incentives to get units occupied, such as months of free rent. Landlords for value-add properties don’t have to offer those kinds of incentives. Plus, they have much better rent growth potential, and the demand is there, for more affordable rentals.
Double Your Investing Benefits
The NREI also pointed out another value-add strategy for people with a longer investment horizon. It writes that the Waterton real estate investment firm purchased an older complex in the Vallejo, California. The entire city has been designated as an Opportunity Zone. That could save Waterton a bundle on any capital gains, years from now, if the project appreciates in value. And that’s what Waterton’s chief investment officer, Rick Hurd, believes will happen in Vallejo. He says, “We believe this area will see significant new investments and job growth due to the tax benefits and the proximity of Vallejo to lots of employment centers throughout the San Francisco area.”
Hurd says of the concept, “It’s definitely harder to find properties.” But, he also says that they are still out there providing a significant discount to what you would have to pay to build something similar from the ground up.
It looks like 2019 is a window of opportunity for the value-add strategy and opportunity zone investment. We’ll be talking more about opportunity zones at our upcoming live event January 12 in San Mateo and January 13 in Los Angeles.
(1) NREI Article
(2) CNBC Article