What does value add mean in commercial real estate?
The value of multifamily apartment communities and commercial real estate in general is based on the net income the property produces or can potentially produce.
Value add investing refers to taking an under-performing property (based on net income relative to potential gross income) and operating it more efficiently to realize a higher net income.
As the net income increases, so will the value of the property which creates equity. The property is then sold or refinanced to capitalize on this increased value or to access the newly created equity.
What is a value add strategy?
The value-add strategy refers to buying multifamily real estate with the goal of improving it rather than purchasing an already efficiently run property and maintaining the status quo. If the property is already efficiently operated its’ value will increase over time through organic appreciation.
Value-add investors speed up this appreciation through forced appreciation. Because this value would not have been created without intervention, they are adding value with each management or operational decision that increases the net income of the property.
How do real estate investors add value?
Whatever operational changes are made that increase net operating income are considered value add. The most common way this is achieved is by finding older unrenovated apartment buildings with below market rents. The apartments are renovated and the rents are increased to market value.
This increases the gross potential income and also the net income which adds value to the property. Because net income is the income minus expenses you can also increase net income by decreasing expenses. This may be as simple as negotiating contracts such as insurance or landscaping to lower the cost.
You can also add amenities at the property such as a washer/dryer or a fitness center. These added amenities make the property more valuable to potential renters who will then pay more or stay longer reducing turnover expenses.