For the last few years, the name of the multifamily real estate game has been value-add. It seems like most investment packages in multifamily promise a value-add opportunity, attempting to attract buyers by forecasting higher returns than the property currently generates.By definition, a value-add investment is one that you can increase revenue through renovation, management or a combination of the two. In addition, these deals can be valued by both a compressed cap rate or an IRR analysis based on a 3-5 year hold. Cap rates have their flaws and an IRR is only as legitimate as the underwriting assumptions behind it, I am certain that within the slew of current “opportunities” there is a high percentage of illegitimate value-adds being passed off as the real thing.
In this two-part series we’re going to take a deeper dive into some of the ways an offering can be skewed, and offer suggestions on how to quickly determine whether or not a deal is actually a value-add.
Look At The Comps
If you’re looking at a broker’s proposal, the most important thing to remember is that a broker’s job is to deliver the most value to their seller. Unless you have a rare, buy-side agreement with a broker, their only contract will be the listing or commission agreement they have with their seller. While seller’s objectives may sometimes deviate based on circumstances, generally they want an offer that has the highest ratio of price to likelihood of closing. This sometimes puts brokers in a bad position, if a seller’s target price is unrealistic and they still want the listing, brokers may influence the offering with rent comps that may not be very comparable at all.
It’s important to investigate the comps one by one. A brand new building with the same value-add finishes you are planning for your 60’s construction acquisition will nearly always generate higher rents. Likewise, if you are looking at a renovation project in a class B neighborhood and all of the comps are in an class A neighborhood, even if the neighborhood is gentrifying you cannot underwrite the same returns. With a manufactured comp set, it’s really easy to add “value” that isn’t defendable in underwriting. If you aren’t careful, you won’t find that out until after the bank appraisal comes back- hopefully it wasn’t a cash offer.
If the rent comps are fishy, the comps were likely chosen with the sale price in mind, not the actual comparability. If you proceed to underwrite the deal, exercise caution and use your own comp set to determine whether the value-add has enough meat on the bone. To see how Enodo takes the guesswork out of which comps are actually comps, request a demo and we’ll run your potential acquisition through the platform.