Financial

A Successful Value-Add Multifamily Real Estate Case Study

One of the things I’m curious about is how real estate crowdfunding platforms add value for their investors after acquisition. Therefore, I asked RealtyMogul to share an in-depth look at one of their successful value-add multifamily real estate deal from start to finish.

When I was a young man, I would enthusiastically spend a lot of time expanding and remodeling properties to add more value. Now, as a middle-aged man with two young children, I simply don’t have the time or the desire any more. I’d much rather pay someone to add value for me.

Let’s take a look at RealtyMogul’s case study to get a better idea of what they do for investors.

Value-Add Multifamily: A Real Estate Crowdfunding Favorite 

One of the most popular asset classes offered on real estate crowdfunding platforms like RealtyMogul is multifamily – specifically, value-add multifamily.

Value-add is an investment strategy where a real estate company identifies that a property is currently operating below its potential.

Typically, rents are below market value. Or the operating expenses of the property are running too high, or both. By making improvements to the property and it’s management, the real estate company can often increase the property’s cash flow and its overall value. The bulk of the returns to investors are generated when the property is sold.

Here is a successful value-add multifamily project case study. It will help you understand the inner workings. The deal featured is from RM Communities – the acquisition arm of RealtyMogul. It is a project called Terrace Hill[1] that most recently went full cycle as of June 28th, 2022.

A Hot Submarket With A Healthy Demand For Rentals

Terrace Hill is a 310-unit apartment complex located in El Paso, Texas. RM Communities acquired it in May of 2019.

Before we dive in, here are several factors that RM Communities looks for in any submarket it considers investing in.

What RealtyMogul Evaluates Before Acquiring A Submarket Property

  • Population growth. People, specifically young adults, are moving into the area at a higher rate than to other areas of the country.
  • The unemployment rate is on the decline. And ideally there are multiple large employers in the area or moving into the area.
  • The average household income is healthy. The people living in the area or moving into it are or will be earning a decent-enough salary that supports a good, sustainable cost of living.
  • Demand for housing is high, as reflected in a low vacancy rate.
  • It’s an area people want to live in – crime is relatively low, the neighborhood is safe and ideally walkable, and it’s close to grocery stores, other amenities and major highways.

The submarket that Terrace Hill is located in met most of the criteria listed above. It is also right near the local university. This usually means there’s a healthy demand for student housing in the form of apartment rentals.

Terrace Hill acquisition by RealtyMogul

At First Glance, The Property Appeared Old And Tired

The seller had owned Terrace Hill for many years and had fallen behind on maintaining the property. The units were also pretty outdated. 

The RM Communities team then looked at rental comparables (also known as “rental comps”). They identified that other, nicer apartment complexes in the submarket were charging higher rents than Terrace Hill, and that a value-add strategy may make sense for the property. 

The team then built a CAPEX budget. That’s a list of all of the improvements, repairs and upgrades that could improve the property and ultimately increase rents. 

Once a CAPEX budget is complete and projected future rents are determined, these inputs are put into a document called a “proforma.” The proforma is an analysis of a property’s potential profit (net operating income) using its current and potential rental income and operating expenses. This process helps determine if a project makes sense.   

Rental comps factor into both of these documents to help determine the maximum rents the property may be able to achieve once it’s been improved.

In the case of Terrace Hill, the team determined that a capex budget of approximately $4.1 million would be required to improve the property enough to command market rents and generate returns that looked attractive in the proforma.  

Then, the decision was made for RealtyMogul to acquire the property in May of 2019 for $18.7 million.

Terrace Hill (El Paso, Texas) acquisition by RealtyMogul in May 2019

Implementing The Business Plan For A Value-Add Deal

Terrace Hill’s value-add business plan consisted of interior and exterior improvements.

Value-Add Interior improvements

A total of 219 of the 310 units were renovated before the property was sold. 

The renovations included upgrading the kitchens with new cabinet faces, new appliances, vinyl flooring and backsplashes. In addition, RealtyMogul resurfaced countertops in the kitchens and bathrooms, and added new hardware, fixtures, lighting, and ceiling fans. And in the bathrooms, adding new water saving aerators, showerheads, and toilets. The units also received a fresh coat of paint.

And in case you’re wondering why only 219 of the 310 units were renovated, it’s common that a real estate company will renovate some, but not all, of the units. The remodeled units are used as a showcase for potential buyers. They show increased rent potential due to the renovations. They also show additional upside capital appreciation for prospective buyers.

Value-Add Exterior improvements

The property’s swamp cooling was changed to refrigerated air (which reduced the property’s operating expenses). In addition, new roofing was added, the exterior was painted and landscaping was improved. 

Our team also upgraded the swimming pool, turned an old tennis court into a new resident lounge area with a new basketball court and open grass area that also included new tables, benches and BBQ grills.

Terrace Hill Pool Value-Add
Value-add to multi-family property acquisition

Property Improvements Led To A 22% Rental Income Increase

Once the upgrades were complete, the average rents at Terrace Hill went from $688 at the time of acquisition to $820 after the renovations. That’s a 22% increase in rental income.

With a value-add multifamily project, once you can demonstrate that the improved property generates significantly more revenue, the property will likely receive a higher appraisal value.

At this time, the property is typically refinanced or sold. If refinanced, a supplemental loan can be used to return part of the original capital invested into the project back to the investors.

With Terrace Hill, RM Communities met its proforma returns having renovated only ⅔ of the units. So, the property was sold in Q4 of 2021 for $27.325 million. That’s a 46% increase in value in just 2.5 years.

Sam’s note. As a reminder, the acquisition price was $18.7 million plus the $4.1 million in rehabilitation costs for a total cost of $22.8 million. Therefore, the total gross return equaled 20%. But as you will see below, the returns are due to leverage.

Return Metrics For Real Estate Deals

The 3 most important return metrics to look at when evaluating any real estate deal are: 

  • IRR (internal rate of return): the expected annual rate of return that the deal is expected to potentially generate, taking into account the time value for money.
  • Equity multiple: how much money you can potentially earn on your investment.
  • Cash-on-cash return: the total pre-tax cash flow you’ll potentially earn compared to the total amount of cash invested.

Terrace Hill’s Final Returns

In the case of Terrace Hill, RM Communities’ initial underwriting projected a property-level IRR of 17.4%, a 2.04x equity multiple, and an 8.05% average cash-on-cash return throughout a 5-year hold period.

We believe the investment will ultimately achieve approximately a 21.8% property-level IRR, a 1.58x equity multiple, and a 5.3% average cash-on-cash return.

Plus, RM Communities broke the record for the sale price of a 1980’s-built apartment complex of its kind in El Paso.

Value-Add Multifamily Case Study Conclusion

Real estate is my favorite asset class to build wealth partially because savvy investors know what to do to boost returns. Whereas with stocks, as minority investors, there’s nothing much we can do to create more value.

As a real estate investor who is finishing up a painful two-year remodel, I view any natural market appreciation as a bonus. The real economic opportunity is always what I can do through remodeling or expansion to boost rents and property prices. My favorite thing to do is create more livable space below the selling cost.

The problem with renovating is the energy required to get permits, go through planning, hire contractors, keep contractors on schedule, procure materials, and find new tenants or buyers once complete.

As a result, I’m glad there are real estate companies such as RealtyMogul to help do the work for us so we don’t have to. There more details I hear about what real estate sponsors do to add value, the happier I am not to have to do the work!

To check out all that RealtyMogul has to offer, click here. You can find individual deals and private REITs.


[1] The most recent value-add deal that has gone full cycle is one in which the asset has been sold and all distributions have been paid to investors.

This article is for informational purposes only. It should not be regarded as a recommendation, an offer to sell, or a solicitation of an offer to buy any security. Any investment information contained herein has been secured from sources RealtyMogul believes are reliable. But we make no representations or warranties as to the accuracy of such information and accept no liability therefor. No part of this article is intended to be binding on RealtyMogul or to supersede any issuer offering materials.

Investment opportunities on the RealtyMogul Platform are speculative and involve substantial risk. You should not invest unless you can sustain the risk of loss of capital, including the risk of total loss of capital. Past performance is not necessarily indicative of future results. RealtyMogul is a Financial Samurai sponsor. For additional information on risks and disclosures visit https://www.realtymogul.com/investment-disclosure.

Source
A Successful Value-Add Multifamily Real Estate Case Study is written by Financial Samurai for www.financialsamurai.com

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