August was a very eventful month for us. We officially closed the sale of two properties for a 90% and 100% return on investment. Since the other properties in our portfolio were purchased this year, we won’t be selling again anytime soon. We’re happy to provide strong returns to our investors who partnered with us years ago.
This month we’ll discuss why we target value-add properties, how it helps us achieve strong returns, and our track record.
Why Do We Target Value-Add Properties?
There are many strategies for real estate investing. Some choose to buy & hold while waiting for market appreciation, perhaps making minor renovations along the way. Others pursue value-add properties and force appreciation by doing renovations. Value-add investing is more difficult than core or core-plus strategies where there are minor renovations (or none at all!). We choose to do heavy value-add renovations as our preferred investment strategy. It requires a lot of work, capital, and coordination. If we get some market appreciation, that is just the cherry on top and it boosts our returns. It has worked well for us so far.
Commercial multifamily is a business, and the valuation of the business is based on a multiple of how much revenue it produces. The NOI (Net Operating Income) is the income minus expenses. With each unit we renovate, we can rent it at market values and increase the NOI. A capitalization rate, also known as cap rate, is the multiplier. It changes depending on the age of the building, condition, location, and if the property is stabilized. In Phoenix, apartments are trading for a 4.0-4.5% cap rate. After we finish renovating a unit, we increase the rent by at least $300/month or $3,600 annually. Below are graphs of the NOI of two properties we recently sold: Canyon 35 and Haven on the Rail.
To calculate the valuation, you divide the NOI by the cap rate. Using a 4% cap rate, each renovated unit with a $300/month increase bumps up the value by $90,000. Then you repeat that with 99 more units. That is how we’re able to achieve our outsized returns.