Updated: Nov 10, 2021
When value-add multifamily deals are done correctly, they can be extremely secure, profitable, and rewarding. However, unfortunately, many investors make a number of key mistakes when they are buying value-add multifamily deals.
If you make certain mistakes when you are buying value-add multifamily deals, it can diminish your profits and create unnecessary headaches for you. In this blog, we are going to go over some of the top traps that many real estate investors fall into when they are buying value-add multifamily deals. Once you know what these traps are, you can avoid them in your own value-add multifamily deals.
Mistake #1: Investing too much in renovation without getting returns
It is true that investing in renovation can often lead to higher returns. But, this only works if you do not overspend on renovations and if the renovations add enough value. Common value-add renovations include flooring updates, minor kitchen renovations, and minor bathroom renovations.
Oftentimes, the deal has been partly renovated and buyers want to take it to the next level and charge higher premiums such as resurfaced concrete to granite. But, this can be a mistake, because tenants are not always willing to pay more money for the “value” that you add. So, just because you spend a lot of money trying to improve the property does not necessarily mean that the prospective renters will agree that the property is worth the rental value that you say it is worth. Also, down the line, prospective buyers may also not agree that your value-add renovations added enough value to justify the price you are looking for.
Too often, multifamily buyers overlook the fact that the seller did not invest more to get higher premiums in the first place. Many people don’t consider the fact that there might have been a good reason why the seller didn’t already make the investments that they are thinking about making. For example, the seller might have already done his or her homework and discovered that people are not willing to pay more for bamboo floors, etc. Whether it’s a buyer’s market or a seller’s market, you should pay attention to what the seller did or didn’t do recently.
The best opportunities for multifamily property buyers to get good ROI on value-add investments is when the seller doesn’t properly understand the market, ran out of money, or has a completely different mindset or business plan than they do. But, even when the opportunity is there, you still have to be careful not to overspend, or you could struggle to get the returns you are looking for. For example, in 2020, the average cost of a major kitchen remodel was $68,490, but the resale value was only $40,127. So, you might want to avoid major kitchen remodels and other similarly pricey renovations that do not tend to generate high ROI. Instead, you should only invest in value-add renovations with the highest chances of providing real property value increases. Mistake #2: Focusing only on renovations that generate immediate returns
A lot of people who make renovations on their multifamily properties are not thinking long-term or about the big picture. Instead, they hone in on a few things that they think will generate immediate returns and they put all of their time, energy, focus on these things. For example, a lot of people will spend money on interior renovations such as redoing the floors, updating appliances, adding new paint, etc. Oftentimes these people will spend $5,000 - $7,000 and they will be able to get slightly higher rents as a result.
However, many of these people do not think about the other renovations and updates they could do to further increase the rent values that they can obtain. For example, exterior work such as exterior paint, power washing, tree trimming, parking lot resurfacing, etc. are all things that people commonly overlook when they are considering investing in renovations for their multifamily properties.
Exterior renovations might not generate immediate returns. But, they are important because even though tenants don’t pay you for it immediately, they help to improve the property’s curb appeal which will help you to attract higher-paying tenants. Oftentimes, improving the curb appeal is necessary to get your property noticed by people with higher incomes and more rental options. You might not see the returns right away on exterior renovations. But, over time, they can really pay off. Also, if you don’t make them, you might hit a plateau. I’ve personally seen many properties that had very nice interiors, but because the exterior was not attractive, the building owners were having a very difficult time attracting tenants who could pay higher rents.
Mistake #3: Not understanding who YOUR buyer is
Multifamily real estate investors do not only need to study the seller market and fully understand who they are buying from, they need to understand who will buy from them. Researching and learning about your potential buyers will help you to fully understand their needs and how to set up the best possible deals to attract them.
Here at Blue Lake Capital, whenever we buy an asset and create a business plan, we know who our buyer is when we exit in 3-5 years, and build the plan accordingly. If we buy a large asset in the 90s or 2000s, our buyer is an institutional and they don’t always like to renovate, so we will renovate all units and sell it as a core deal. A core deal is an extremely safe real estate deal that usually generates 7-10 percent annualized returns with very low risk. Core deals typically have credit tenants who are on a long-term lease with a strong guarantor. These types of deals are often compared to bonds due to their low risk profile and stability.
Smaller assets can be sold to a real estate company that will want some “meat on the bones” and will want to have enough units to renovate. So, we’ll renovate only half the units to make sure it is attractive to the next buyer. Some investors make the mistake of not thinking about their own buyer and execute a plan that doesn’t sit with the way their buyer thinks. In other words, it is not only important to make sure that your purchase of the property is sound financially, but that your exit from it is sound as well and that your exit strategy resonates with your prospective buyers.
If you want to optimize your return on investment for your multifamily real estate deals, then you need to proceed carefully and intelligently to avoid making some of the most common mistakes. This means that you need to avoid spending too much on renovations that do not justify higher rent prices, avoid only making renovations that lead to small and immediate rental increases, and make sure that you do not forget to research and fully understand your prospective buyers.
If you can avoid these three classic real estate investing mistakes, then you stand a much better chance of getting the best possible returns on your multifamily property investments and avoiding situations where you lose money or fail to make significant returns.
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About the Author
Ellie is the founder of Blue Lake Capital, a commercial real estate investment firm specialized in multifamily investing throughout the United States. At Blue Lake Capital, Ellie partners with both institutional and individual investors to grow their wealth by achieving double-digit returns by investing alongside her in exclusive multifamily deals they usually don't have access to.
A defining factor of Blue Lake Capital’s strategy is founded in utilizing machine learning/artificial intelligence throughout the course of all acquisitions and asset management. This advanced technology enables the company to produce accurate and data-driven forecasting for all assets on a market, property, and even tenant basis. In doing so, Blue Lake is able to lead commercial investments with the full capabilities of today’s technology.
Ellie is the host of REady2Scale , a podcast that highlights honest, insightful, and thought-provoking discussions on the multiple approaches for successful real estate investing.
She started her career as a commercial real estate lawyer, leading real estate transactions for one of Israel’s leading development companies. Later, as a property manager for Israel’s largest energy company, she oversaw properties worth over $100MM. Additionally, Ellie is an experienced entrepreneur who helped build and scale companies by improving their business operations.
Ellie holds a Masters in Law from Bar-Ilan University in Israel and an MBA from MIT Sloan School of Management.
You can read more about Blue Lake Capital and Ellie Perlman at www.bluelake-capital.com.