In our Fall 2016 market report we discussed an expansion in the acquisition criteria of many large area and national buyers from strictly core/core+ product, to include value-add opportunities as well. This was brought on, in part, by increased competition from national buyers in the class A arena, as well as, a three year low in new unit deliveries.
With a full year of value-add investing in the rear view mirror, evidence of the strategy can be found in analysis of current market statistics. The most telling of which is the 7.1% annual rent growth that has occurred in buildings built prior to 1970. The next closest build decade is the 1970’s with a 5.7% annual rent growth figure. This increase in rents has not been at the expense of occupancy either, as pre-1970’s building owners continue to enjoy some of the highest occupancy seen market-wide at 98.3% (1970’s build are at the top with 98.4%). Having this type of average rent increase while retaining tenants points us to the explanation that many of these building operators are pursuing a value-add strategy to drive demand and boost rents.
The Turnaround Story: Value-Add in Action
It is clear that value-add strategies have become a popular investment vehicle in the Twin Cities. We have observed many of these transactions in recent years, but wanted to understand the financial mechanics from an operational point of view.
Our example is right outside of Uptown in the West Calhoun neighborhood. The 100-plus unit property was built in the 1970s, and the current owner purchased it in the early 2000’s. They have been renovating units opportunistically as they turnover.
We followed the turnover of a one bedroom, one bathroom unit, with original finishes from the 1970’s. The bulk of the renovation focused on two predictable areas: the kitchen and the bathroom. Other improvements included luxury vinyl planking in the entryway and white trim and doors installed throughout the unit. From an ROI perspective, these aesthetic improvements typically yield the highest return in terms of rental rate increases. The renovation cost breakdown is approximated as follows:
One-time renovation upgrade costs
In its original state, this one-bedroom was commanding $1,065 per month. After a one-month renovation during the Winter of 2017, management had no problem leasing the unit at $1,165 for a net rent increase of $100. Assuming that operating expenses remain the same after renovations, the annualized cap rate of this investment comes out to 14.29%. The actual rate could be even higher when an operator takes into account the long-term maintenance savings of vinyl flooring versus carpet, or if they install high efficiency appliances.
In a tight market, where multifamily properties are being acquired at all-time low cap rates, savvy investors are now hitting their return targets through value-add development.
SEE THE FULL: Minneapolis St.Paul Spring 2017 Apartment Market Report