The 5 Steps Of Value-Add Multifamily Real Estate Syndications
The 5 steps of value-add multifamily real estate syndications. Remember Remember the 5-paragraph essay from elementary school? Some of us, myself included, are reliving this process as our kids go through elementary school. It’s amazing how things come back to you, right?
Anyway, back to the 5-paragraph essay. If you remember, this format provides a framework where there is a central idea, three supporting ideas, and then a summary. By following this format, students are able to focus their ideas and present them in a clear and organized way.
We can use a similar structure when looking at the framework of a value-add asset. Let’s dive in a little more and walk through this together.
The Five Phases of a Value-Add Commercial Asset Syndication
Every real estate syndication follows a series of steps that have a distinct starting point, middle, and end. This process guarantees that each team member works together as a cohesive unit, following a well-defined business plan.
Step #1 – Acquisition Of Multifamily Real Estate Syndications
Multifamily real estate syndications are similar to other real estate investments and are a great value-add to your portfolio. The initial stage of any real estate investment involves the acquisition of an asset, or property, under contract by the sponsor team. However, this is not an easy task. This process requires a lot of time just to find the right opportunity that pencils out during underwriting. Tens, if not hundreds, of properties are run through an underwriting process before a diamond in the rough is found.
During the underwriting process, the sponsor team analyzes the property’s potential returns carefully, including cash flow and ways to force appreciation, to determine its viability as an investment. The property’s location, market trends, and economic indicators are also taken into consideration to project its potential value in the future. The goal is to “break” the deal, or find anything and everything wrong with the deal, any reason not to move forward. And if we can’t break it, then we pull the trigger. Therefore, the first stage of any real estate investment is crucial to the success of the entire investment process.
After the contract is signed, sponsors put in a lot of effort on due diligence. This takes a lot of time and money as the team identifies the property’s requirements, estimates expenses (often by getting numerous quotes for various line items of expenses including debt service), and revises the business plan accordingly. There is a deep dive into financials, rent rolls, P&L statements, competitors in the marketplace, secret shopping other assets in the area so we have a handle on the market rents and where we can push them. Once we are all satisfied with the research, the deal, and the forecasts, we present the deal to potential passive investors, like yourself, to determine the level of interest in an opportunity like we have at hand. Once all investors have signed the subscription documents and contributed their funds, we can proceed to finalize the deal by closing on the asset, or acquiring it.
Step #2 – Add Value With Multifamily Real Estate Syndications
To put it simply, the expression “value-add” refers to the act of increasing the value of an asset, which is why renovations are generally started quickly after the asset has been acquired. One of the best ways to value-add is with multifamily real estate syndications.
The property management and asset management teams follow the business plan that was laid out before closing. Any planned renovations are done, both for the interior and the exterior, leases are renewed under new management at new rates and terms and any additional plans to force the value of the asset up are executed. This step may take around 12 to 18 months, or more, depending on the duration of tenants’ lease agreements and the level of renovation of any outdated units.
The team often implements improvements to the exterior and communal areas, such as modernizing or introducing new lighting installations, creating a designated area for dogs, adding covered parking, or enhancing the landscaping.
There are many ways to force appreciation. Here are some of the way we force appreciation on assets we have closed on:
Renovate units and increase rents: This is a strategy that is frequently used, especially if there have been little or no interior renovation for decades, which can be the case, especially when purchasing the asset from a “mom-and-pop” operator. By renovating the units, we can attract higher-paying tenants who are willing to pay more for modern amenities and updated living spaces.
Push rents to market rents: This refers to the practice of increasing the rent of a property to match the prevailing market rates. In many cases, landlords may have previously charged rents that are below market rates, either due to a lack of awareness of the current market or a desire to maintain long-term tenants. This is very often the case with “mom-and-pop” operators where they may have minimally increased rents in recent years, or sometimes not at all. However, as market conditions change, operators typically increase rents to match the current market rates. We often do this incrementally in an effort to keep tenants or when leases renew and/or when new tenants come in.
Covered Parking: Covered parking is considered a desirable feature for many people, and it can be a great convenience to tenants. We find they are often willing and able to pay the additional $20-30/mo for that convenience.
Professional Management (decreases costs): One way to reduce expenses is to focus on expenses you can affect, unlike insurance and taxes, in areas such as maintenance, repairs, and operations. This can be achieved by implementing more efficient systems and processes, negotiating better contracts with suppliers, and optimizing the use of resources. Ultimately, by decreasing costs and improving performance, professional management can force the value of an asset higher, resulting in better returns for investors or owners.
Late rent fees: When a tenant fails to pay rent on time, we have the ability and right to charge a late fee as a penalty, just like when you pay a credit card bill after the due date. This late fee is typically a flat fee and is used to incentivize tenants to pay on time.
Utility fees: Another way to decrease expenses is to bill back tenants for use of utilities. Depending on the state, you can do this by implementing a flat utility fee, which is the same for all tenants, or by billing the tenants back for the utilities they used. When billing back tenants for the utilities they are directly using, we often have to put individual meters on each unit. There is an upfront cost to this but the payback can be worth it since it directly impacts the net operating income and, therefore, the value of the asset overall.
There are just some of the ways the sponsor team, or general partners, can force the appreciation of the asset, or incorporate their value-add business plan to benefit the asset, which positively affects both the limited partners and the general partners.
Step #3 – Refinance
The purpose of implementing the business plan, which often involves renovating commercial properties, is to increase their value based on the income they generate. This is done by implementing many of the ideas in step #2. But to really see the impact, let’s do some math (trust me, you’ll like this math!).
For example, if a 100-unit apartment complex charges an additional $100 per month for updated units, it could potentially generate an additional $120,000 per year in rental income. This would translate to an increase in equity of $2,000,000 at a 6% cap rate.
Did you get that? $2 Million dollars in increased value (forced appreciation) just by increasing rents $100/unit per month! I told you you would like this math 😉
Having more equity allows the sponsor the opportunity to refinance or sell the property prematurely if market conditions permit. However, it should be noted that neither of these options are certain. If a refinance is pursued, you may receive a portion of your initial investment, or capital contribution, back, while still maintaining the same equity position in the deal as you originally had. This can be very powerful because you can take any funds that come back to you and invest them in yet another offering. This allows the same money to work twice as hard for you (because it is still working for you in offering 1).
Step #4 – Hold
The subsequent stage involves retaining the, now stabilized, asset while receiving cash-on-cash returns, commonly known as cash flow. As the phases that enhance value have been completed and the heavy-lift stages have been surpassed, attention is now directed towards procuring the right tenants and producing substantial, consistent revenue.
During the hold period, the rent will go up every year by a small percentage, which will gradually increase the revenue and aid in the steady appreciation of the property. The duration of this period, which is usually around 5 years or less, depends on the particular property, sponsor, and business strategy.
Step #5 – Sell
This is where things get really exciting!
In this stage, the property boasts renovated units and exterior spaces, higher earnings, and decreased expenses. Therefore, it is often most beneficial at this stage for all parties to sell the property and move on to their next investment venture.
In the process of selling the property, the sponsor team makes the necessary preparations for the sale. Often, and very typically with commercial real estate, the asset can be sold without being listed on the market, causing little disturbance to tenants. Alternatively, sponsors must navigate through the entire selling process.
After the sale is finalized, you will receive your initial investment back along with a portion of the proceeds and it’s time to celebrate!
There you have it!
The 5 steps of value-add multifamily real estate syndications. Each step of a syndication has a structure, exchange of information, and focus. However, it’s important to note that every deal is unique and not all syndications follow every phase.
If you’re an investor who prefers a hands-off approach, you don’t have to do all the groundwork yourself. As you can see, there is a lot of work that goes into each asset.
However, it’s still important to have a comprehensive understanding of the typical steps of a value-add business plan, so you can stay knowledgeable throughout the entire process.
Want to find out more, hop on a call with Angie, Owner and Founder of Ohana Investment Partners, by clicking HERE.