As important as the purchase and sales prices are to maximizing investor returns, the strategies for how a property is managed in the middle, between acquisition and disposition is critical for executing a value-focused business plan: Value-Add or Next Value-Keep®.
Value-Add
Among the most common methods for adding value include making physical improvements to reposition an asset which creates the opportunity to increase rental income. That makes the property more marketable to prospective tenants and increases the value for prospective investors. An asset that is more marketable is likely to achieve increased rental rates, occupancy levels and cash flow. As these increases occur, tangible value is added for the benefit of the investor. Next Realty has a long track record of executing successful value-add investment strategies throughout its 25+ year history.
For example, an affiliate of Next Realty acquired an under-managed multi-tenant neighborhood shopping center in Harwood Heights (suburban Chicago). The firm developed and executed a customized property renovation plan centered on upgrading the physical appearance of the center’s façade. Also included in the overarching plan was relocating certain tenants to maximize their business and to create additional leasing opportunities. In 18 months, the addition of new tenants at higher rental rates increased net operating income by 125%. Upon disposition, the improvements translated to a $3.5 million in value creation.
Next Value-Keep®
Years ago, Next Realty coined this specific term to describe the acquisition and management of properties that preserve capital with predictable, sustainable cash flow over extended periods of time and varying economic conditions.
Sometimes those investments involve acquiring a property where a strong, creditworthy tenant has made a long-term commitment to occupying a specific asset. A variation of that could involve acquiring an asset occupied by a strong, credit-worthy tenant and then renegotiating and/or restructuring the lease terms to extend the duration of the lease. Again, property values are maintained or enhanced when lease terms produce predictable cash flow streams and significant lease term remains on the lease.
For example, several years ago, an affiliate of Next Realty acquired a 50,000-square-foot industrial warehouse facility that was fully leased by Fiserv, a publicly traded investment-grade tenant, in Nashville. However, upon acquisition, there was only a limited amount of lease term left. Through careful negotiations, Next executed a long-term lease extension that provided a guaranteed, market-rate income stream and significantly enhanced market value. That allowed Next to sell the property and produce a net investor equity multiple of 2.3x.
As demonstrated by these examples, Next Realty proved it’s not solely the value that that you add … it’s also the value that you keep.
About Rent Growth and Why It Matters
The value of a property is largely determined by the net operating income (income less expenses) it produces. The cornerstone of the value-add investment thesis is that when rental income is increased value typically follows suit.
Consider the following scenario: an investor buys a 50-unit multifamily asset as a value-add investment. At the time of acquisition, 44 of the units are occupied at an average rental rate of $1,000 per month. That equates to an operating income of $44,000 per month, or $528,000 per year.
Within six months of acquisition, the investor completes standard upgrades to each unit that along with bringing rents up to market levels are sufficient to increase rents by 25% to $1,250 per month. Further the improvements create greater demand and bring occupancy up to 48 units. Thus, in addition to increasing the rental rate, the investor has increased the number of units that are generating income. As a result, the building is generating $60,000 of monthly income or $720,000 annually.
Based solely on the income, but assuming the investor keeps property expenses in check, the value of the asset would have been increased proportionately.
