Modeling Value-Add Apartments

Realstate's picture
Rank: Monkey | banana points 34

Hi guys!

As many of you know, multifamily caps are extraordinarily low in Manhattan and the surrounding boroughs. This holds true for properties where the majority of the units are rent stabilized. However, these types of properties provide a value-add opportunity for those that wish to hold for the long term (i.e. potentially longer than 5 years). Value is added through capital improvements, as well as unit renovations when units become vacant and marked to market.

Does anyone have any experience modeling these types of investment, and if so, could you kindly share your model?

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Comments (33)

Feb 10, 2017

I won't share a model but feel free to PM me with any specific questions.

Feb 10, 2017

Yes, but also won't share model. Not too complicated though, what would you like to know?

Feb 11, 2017

You could Pm Me too or ask a question here but also I'm not going to share a model.

Feb 10, 2017

You pm'd me but would prefer if you asked in a comment so others could see

Best Response
Feb 11, 2017
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Feb 11, 2017

I don't know what I appreciate more, the sample case studies or the models -- thanks Count.

Feb 12, 2017

Honestly, mate, multi-family value-add might just be the easiest model to build from scratch. I'd work on getting good at building a simple version on your own before messing around with the pre-built type.

    • 1
Feb 13, 2017

We need to be more specific in how we predict unit turnover downtime four years from now!

Feb 11, 2017

That's what I was basically getting at with my original post. Taking a deep dive in the rent role, doing some heavy research/recon and then building a model around "what ifs." I guess it's not as complicated when I put it that way, but it would be nice to build something a bit more dynamic.

Most groups don't model assuming rent turnover unless they have LOI's signed from tenants accepting buyouts.

Mar 11, 2017

what is the average buyout number, at what rate does everyone discount it to?

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Mar 22, 2017

Modeling value-add multifamily is pretty easy in practice. carry current rents at what they are and then add in the "value add" component...say $100/mo per unit. It falls to the bottom line.

The real issue is not on the gross rent contribution from value-add, but rather the timing of those cash flows and the impact construction has on occupancy and other costs (R&M, Turnover, etc). None of that is tricky, it just takes some time/experience to work through it.

My model is overly complex, but simple.

Apr 4, 2017

I find that the BIGGEST and most common error in modeling value-add MF is how analyst's treat the rent roll and "rolling in" of renovated units. You need to specify the premium on renovated units, how many will be leased up per month, and make sure you are not double counting or discounting yourself by not treating it properly. PM me if you want to see an excel example on illustrating this point.

Feb 11, 2017
Post hoc ergo propter hoc:

I find that the BIGGEST and most common error in modeling value-add MF is how analyst's treat the rent roll and "rolling in" of renovated units. You need to specify the premium on renovated units, how many will be leased up per month, and make sure you are not double counting or discounting yourself by not treating it properly. PM me if you want to see an excel example on illustrating this point.

Yes. And at the end of the day, it's still just a guess depending on what type of protection tenants have. You can assume that you are going to renovate 4 units per month, but the tenant can tell you to pound salt. Or, they can say sure, but they want a month free, etc. etc.

Apr 4, 2017

Agreed - I think it would be foolish for an acquisitions office to project a renovation schedule that exceeds their average rollover. Typically, when I've worked on these deals, I've looked at the size of the building, historical rollover schedules...how the seasonality will effect it (have a lot more rollover in the summer months for MF, etc)...after having this baseline, then I'll project the completion schedule.

After all - its very easy to see exactly what date every unit will turn. You just need to plan/structure your renovations around this timeframe.

May 26, 2017

Same with pretty much everyone here. Won't just give you my model that I've worked on for the past 6 months, but feel free to PM me with questions.

Things to keep in mind when modeling a value-add multi-family asset:
1. Renewal rates can be aggressively increased (residents will either pay the increase in rent - fuck yeah - or they bail and you start renovating)
2. Average Days Vacant will increase, therefore causing Vacancy costs to increase.
3. Market Rent will begin to trend upwards as more renovated units come to market and the expected premium is taken into consideration in addition to current in-place rents.
4. Turn Costs (Redecorating R&M) will decrease because you won't necessarily be turning units, you'll be renovating them and throwing the costs associated with the redev process below the line as CapX.

Longer term effects:
Bad Debt for rent ant other income and late fees could potentially decrease as a result of attracting a different demographic of people. Higher rents --> higher income residents. More disposable income, in my experience, corresponds to residents paying rent on time and in full.

Jun 6, 2017

Great post. As an operator, focusing on renewal rates and avg days vacant really makes more sense than focusing on vacancy (output). One thing I'd stress is that many analysts try to be conservative and model 30+ days of avg days vacant which may be realistic but in a monthly model you end up compounding and double counting vacancy loss.

Jun 6, 2017

Just an FYI, if your goal is to improve property occupancy and to improve the physical asset then there is no point in running valuations using cap rates and free cash flows--it sounds entirely superfluous. Also, it doesn't sound like your goal is to increase rental revenue per se, but to increase occupancy. If that's the case then focusing on increasing rental rates is counterproductive--that may actually exacerbate vacancy issues.

The best way to turn around a distressed property is to hire a better management company. The property is probably distressed for two fundamental reasons: 1) poor capital expenditures and 2) poor management.

If it were me in a real life scenario I would hire a 3rd party to conduct a physical needs assessment (PNA) to determine all the issues with the property and to determine an approximate cost to remedy (a good PNA could run you $5,000 but would be well worth it). Once you've determined that critical information then you need to look at your available funds and complete all the required repairs or consider triage--the most critical and apparent things first, then budget annually for the additional and future needs.

Hiring a new management company could be critical. In addition to looking bad because of deferred maintenance, you've probably got management that has bad online reviews, poor customer service, and a poor understanding of the rental market. Hiring a new (and good) management company could bring you better service, marketing, maintenance, and rental pricing.

Finally, if you're at a halfway respected large university then the library should have some cost estimate books (although they will probably be dated). Most commercial appraisers order a book annually that is the authority on cost estimation.

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Jun 6, 2017
DCDepository:

Just an FYI, if your goal is to improve property occupancy and to improve the physical asset then there is no point in running valuations using cap rates and free cash flows--it sounds entirely superfluous. Also, it doesn't sound like your goal is to increase rental revenue per se, but to increase occupancy. If that's the case then focusing on increasing rental rates is counterproductive--that may actually exacerbate vacancy issues.

The best way to turn around a distressed property is to hire a better management company. The property is probably distressed for two fundamental reasons: 1) poor capital expenditures and 2) poor management.

If it were me in a real life scenario I would hire a 3rd party to conduct a physical needs assessment (PNA) to determine all the issues with the property and to determine an approximate cost to remedy (a good PNA could run you $5,000 but would be well worth it). Once you've determined that critical information then you need to look at your available funds and complete all the required repairs or consider triage--the most critical and apparent things first, then budget annually for the additional and future needs.

Hiring a new management company could be critical. In addition to looking bad because of deferred maintenance, you've probably got management that has bad online reviews, poor customer service, and a poor understanding of the rental market. Hiring a new (and good) management company could bring you better service, marketing, maintenance, and rental pricing.

Finally, if you're at a halfway respected large university then the library should have some cost estimate books (although they will probably be dated). Most commercial appraisers order a book annually that is the authority on cost estimation.

Oh awesome! Thank you for your insights. I will definitely look into the cost estimate books. I just asked my teacher what he really wants from us, and he basically said what you said. Mainly physical needs and management considerations.

For this property, I noticed their monthly bad debt expense is $20,000, and their total rent income (inc. concessions, bad debt, and vacancy loss) is only 350,000. So this is certainly an area of concern and some improvements can be better screening of the residents and more guidelines for that. Our professor wants us to present solutions like this, so not necessarily from a pure finance perspective.

What are some other major line items I should look out for? Or maybe some ratios I should look into, such as comparing operating expenses to something?

Jun 6, 2017

I would look at your debt coverage ratio and your actual cash flow from operations. If your cash flow is negative then you've got some serious fundamental issues. If your cash flow is negative even after accounting for almost full occupancy then you're probably looking at loan default. Maybe your investor owns several properties and he'll need to get cash from those other properties that are performing. Maybe robbing cash from those properties will cause a death spiral of the portfolio.

It's difficult to analyze without knowing what perspective you're coming at this from. Are you the special assets team of a bank looking to re-work the loan? Are you an equity investor analyzing distressed property opportunities? Are you a regulator? Municipality? Community stakeholder? How you deal with the property's issues kind of depends on your perspective.

Jun 6, 2017
DCDepository:

I would look at your debt coverage ratio and your actual cash flow from operations. If your cash flow is negative then you've got some serious fundamental issues. If your cash flow is negative even after accounting for almost full occupancy then you're probably looking at loan default. Maybe your investor owns several properties and he'll need to get cash from those other properties that are performing. Maybe robbing cash from those properties will cause a death spiral of the portfolio.

It's difficult to analyze without knowing what perspective you're coming at this from. Are you the special assets team of a bank looking to re-work the loan? Are you an equity investor analyzing distressed property opportunities? Are you a regulator? Municipality? Community stakeholder? How you deal with the property's issues kind of depends on your perspective.

Thanks for your response! I will be sure to look at the debt coverage ratio. I am pretty sure they have positive cash flows though. This project takes a simpler view, moreso from a property management perspective. So, just finding line items or ratios that could use improvement, and how you would improve upon them.

Jun 7, 2017

For one of the more distressed m-fam properties I purchased, we hired a full time security guard that also acted as a liaison between the mgmt. co. and tenants. It was actually pretty amazing how quickly that helped turn things around. DCDepository is spot on for the rest - all about property management and deferred maintenance. Op Ex should run around 35-40% of EGR - more or less depending on asset class, demographics, location, etc.

Jun 6, 2017
pe_re24:

For one of the more distressed m-fam properties I purchased, we hired a full time security guard that also acted as a liaison between the mgmt. co. and tenants. It was actually pretty amazing how quickly that helped turn things around. DCDepository is spot on for the rest - all about property management and deferred maintenance. Op Ex should run around 35-40% of EGR - more or less depending on asset class, demographics, location, etc.

okay, thanks for the op ex ratio! This property is located just outside of Atlanta, so I will be sure to look at that ratio. One of the main concerns on this property is maintenance related and I will definitely look more into ways of solving these issues. The security guard sounds like a good edition too. This property has a lot of bad debt from rent and tenants being kicked out, so that would certainly help. Thanks!

Jun 7, 2017

Since we are in the age of technological disruption age you may want to discuss minimizing expenses by using some online management tools including payment by tenants.

Jun 7, 2017

without reading thorugh the OP and the rest of the thread, to see if the deal has any potential, you need to study the market. Researching rents/occupancies/etc in the neighborhood can be not fun, but if the potential is not there, then a value-add proposition is completely worthless, no matter how much time you spend debating DSCRs, management fees, appliances, and management companies.

you need "headroom." you need upside potential. if none of your competitors are performing any better than you, then it might not be the right market to go pouring money into your asset.