Is Value Add The Answer...YES
If you’re not a Vegas type to rely on having the luck to time a market. And you want to make fast money in real estate. While living in a desirable, expensive, and competitive city. The answer is buy properties, as expensive as they may be, and quickly do things to make them worth even more.
That is value-add investing. And this is how you can afford to pay more than anyone else when buying, and not sit out on the sidelines hoping things bottom out one day and you’ll pick up a deal.
Los Angeles, like so many mid size or major cities, is a strong market to do value add investing. What that is exactly, why it’s so incredible, and how I’ve personally been implementing the approach is what I want to share. The What, why and how.
What -
Value add is exactly what it says it is; adding value to a property. The good part is there are countless ways to achieve this. Simple things are not so expensive like landscape, exterior lighting, or maybe building a laundry shed with one set of machines shared by a few tenants. Then you have the bigger ticket investments. One of these is a major value increase to your property, building ADUs.
In 2017 Los Angeles started to allow Accessory Dwelling Units for homes, and in 2020 on multi family properties. In 2019 the ADU permit was being pulled at LADBS in one out of five applications. An incredible value-add play is if you have a duplex with a garage, you convert that garage to an apartment unit, and make what was a two unit building into a triplex. Or, as I and partners at a 8 unit building are in the midst of doing (the framing pictures for this blog)--add two ADUs, making it into a 10 unit.
The mid level and most common value add in multi-family investing is renovating units. The pricing ranges from 25k-60k, and allows you to achieve market rents on that unit once completed. Incorporating in unit laundry, AC, hard surface flooring, better windows, can be included. Only doing a light fluff with mainly paint, fixtures, and flooring will help bring rents up, but you don’t get top of market for the unit.
When buying in a city such as Los Angeles you need this to make the real money. You should be seeking out the value-add opportunities, and knowing before you make the offer exactly what the plan to improve will be. Being your contractor, designer along to showings—and lean on your realtor for other ideas they have seen work.
You can also define what you will do, by what the return on investment will be, and how long to see that return. On a unit flip, you can see the expense repaid in maybe 3 years:
Example -
$40,000 renovation
generating an extra $1,000/month in rents
takes 3 years & 3 months to become profitable
BUT, there is more to that return, which takes me to the why of value add investing.
Why -
It’s not only about Cash Flow, but also evaluation. Another major reason for the value -add approach in real estate is your assets appraised value increase. The unit that’s been renovated for 40k may take three years to have the cash flow become positive after delaying the capital to improve, BUT the value of the building has shot up. Not only does it feel good that you in essence, have “money in the bank”, but if you go to refinance the property, your chances of paying off borrowed money to have made that 60K unit reno can more easily be paid back. Or you may be looking to cash out, and take proceeds to another project. (The BRRR strategy discussed so perfectly here https://www.biggerpockets.com/guides/brrrr-method).
And this is how that 60K spend will look in that instance:
60K allows for 12,000 more in gross rents
Bank appraisers evaluate that gross income boost on a Cap rate basis
Your 12K boost is 8K Net
dividing the $8,000 by 4.5% cap rate = $177,000 of increased value to your property
Or let’s say I was selling your SFR that you converted the garage into a 1 bed ADU, we wouldn’t use a cap rate as much, but based off comps seeing what four bed house sells for, compared to a three bed, we could likely be listing for 250K more—and the ADU cost to build should have been half that amount.
These are some of the Why’s. There are others, and they are less obvious -
Let’s say your landscape and create a garden, or better curb appeal. As a result of that you find better tenants, who are happier, and makes being a landlord more pleasant and enjoyable. That’s work that adds value in itself.
In prime markets if you’re not value adding properties, the investments are hard to make pencil. Buying a 6 unit building at a cost of $350,000/door and only getting $6,500 per month is gross rents, you will lose money each month. Value add by adding an ADU, updating units as they empty, or removing an old shed and freeing up more parking will get you closer to positive cash flow, while at same time increasing asset value and the experience for both you and the tenants.
And again the ways are countless. And so for the How, I am sharing in list format:
How (examples of Value Add) -
Multi Family Specific -
Conversing a den into an additional bedroom
Adding laundry or AC
ADU for additional 200k-400k in evaluation
Exterior paint, landscape, lighting and Hardscape
Renovate units to increase rents
Update tech: EV charger, Amazon locker, security
SFR Specific-
Renovate kitchen and baths
Expand sq ft for an expanded rimary suite or extra edrooms
Add an ADU
Outdoor amenities like: decks, pool, or kitchen
New windows and doors
Opening walls to outside for optimum indoor/outdoor flow
Taking down dining rooms walls and opening house
In conclusion, a hot market with low inventory can either push you out, or if embraced, can draw you in. Value-add investing has worked for me, and many of my clients. Any ideas I can help you explore on this, it would be my pleasure to do so.
