One of the most lucrative strategies in apartment investing is what’s called the “Value Play” (or “Value Add” to some people). Because I plan to make the Value Play one of the cornerstones of my investing strategy, I wanted to spend some time explaining what it is, and why it can be so lucrative.
At its most basic, the Value Play strategy is very much a method of flipping apartments. But, unlike the traditional flipping of houses (where you add a room, replace the fixtures and slap on a new coat of paint) the Value Play goes right to the heart of increasing the value of an apartment building — increasing its net operating income (NOI).
If you recall from a previous post about the (other) Golden Ratio, for every $1 you can increase the NOI of an apartment property, you can increase its value by $10. And this is what the Value Play is all about, increasing the value of the property by increasing its NOI. As was discussed in our Financial Analysis tutorial, the NOI is what’s left over after you subtract all the annual property expenses from the annual property income. So, to increase the NOI, you can either increase the property income or decrease the property expenses.
Here are just a few things you can do to increase NOI in the real world:
- Increase Monthly Rent
- Add New Income Streams
- Decrease Property Taxes
- Decrease Expenses
- Hire Better Management
As you can see above, by doing some very basic things (like increasing rent and decreasing costs), you can significantly raise the value of an apartment building. But, for some reason, many property owners don’t realize how easy this is (or they do realize it, and are just too overworked or lazy to do it). More commonly, the owners live out of town and/or haven’t done a very good job of selecting and managing their property management company. The property is undervalued due to basic mismanagement by the current owners.
That’s where the Value Play strategy comes in. By buying mismanaged properties, and making relatively simple changes to increase the NOI (and therefore increase value by 10x more), smart investors can make a lot of money very quickly.
Here’s an example:
Let’s say you are considering buying a 30 unit apartment building. The NOI is $90,000 per year, and owner is asking $900,000 (for a cap rate of 10%).
Based on the research you’ve done, you’ve found that the rents in this particular building are $50 per month less than what the going rate was for similar apartments, and you believe you can raise rents $40 per month without losing any tenants. At $40 per month x 30 units, that’s an extra $1200 per month in income. Over the course of the year, that would be $14,400 in extra income (12 months x $1200 per month). Using the Golden Ratio, that $14,400 in additional income would translate to $144,000 in value on the property!
If all you do is buy this property at $900,000, and then raise rents by $40 per month, you’ve almost instantly made $144,000 on your investment! Now that’s the Value Play at work.
So, what are some of the other things that you should be looking for when considering purchasing a property as a value play?
Increase Rent: Is the current rental rates for the property below market? Can landscaping and other aesthetic things be done to increase the perceived value to tenants? Are there tenants who are far behind in rent and haven’t been evicted? All these problems can be easily solved and can quickly increase property income;
Add New Income Streams: Is it possible to add laundry facilities to your building to bring in more income? How about renting out the limited number of garages or extra parking spaces? Can you add soda machines, an ATM or other amenities that can generate more income? Remember, all this extra income goes right towards an increase in your property value, at a ratio of 10 to 1;
Decrease Property Taxes: Many apartment owners don’t think to have their properties reassessed for taxes in situations where property values have decreased. Many times, several thousand dollars per year can be saved in taxes on properties that are reassessed;
Decrease Expenses: Is your advertising budget being wasted on useless advertising methods? Does your plumber charge more than most of his competitors? Can you finding adequate insurance coverage for less money? By decreasing core expenses, NOI is increased, as is the value of your property;
Hire Better Management: This is often the crux of the issue that the current owner is having — poor management. Perhaps the existing management team doesn’t devote enough time to this property? Or worse, perhaps they are fraudulently overcharging for services and repairs that aren’t being completed? Maybe they don’t know the area rental comps well enough to accurately price the rental units? Regardless, poor management is the biggest contributor to undervalued properties…and the biggest opportunity a Value Play investor can find.