Before the pandemic brought economic upheaval, multifamily value-add investments followed a reliable path: Buy a property, make upgrades, and enjoy strong returns. That process may have felt like a sure thing just a few years ago, but times have changed.
By David Hansel
Before the pandemic brought economic upheaval, multifamily value-add investments followed a reliable path: Buy a property, make upgrades, and enjoy strong returns. That process may have felt like a sure thing just a few years ago, but times have changed. Ongoing market volatility has reshaped multifamily valuations, and today’s investors face new challenges around the cost and timing of an asset’s renovation and repositioning. This is amplified by regional economic shifts, as some areas are now unable to sustain higher rents. The current uncertainty surrounding value-add plays underscores the need to assess local market conditions.
With that in mind, let’s take a closer look at the forces shaping the landscape of multifamily value-add and how investors can adapt their strategy in response.
Many markets have experienced significant changes recently, putting certain investment types more in favor. This shift makes the need to stress-test underwriting even more critical. Without it, investors will struggle to take advantage of the value-add opportunities that currently exist in strategic markets. Many Sunbelt markets have multiple factors that can benefit value-add plays—including inbound migration, rising wages, and strong local economies. However, not every Sunbelt market is a favorable one. Really understanding your team’s skillset is more critical than ever. To properly test a range of economic scenarios and determine the potential effects on property cash flow and investment returns, you need the right data and intel. For example, are rents flattening, or is there an influx of new inventory coming to the market? To make informed decisions, you will need vital intel from a robust network in the markets where you invest.
Loans Are Becoming More Expensive
Another variable for investors to consider is the increasing cost of procuring financing to acquire assets, which has significantly shifted the economics of a deal. The biggest impact on loan terms is that proceeds have been cut, so much more equity is required. Sale prices have yet to adjust to offset interest rate hikes fully, and an asset that looked attractive six months ago may have lost its luster in today’s economic environment. In addition, a standoff often exists between buyers and sellers, echoing the dynamics of home buying: While the buyer aims to achieve a healthy return, the seller holds out for the original asking price. According to experts’ estimates, rate hikes have pushed valuations down between 8% to 15%, with value-add opportunities reaching double digits. And, leverage is just as important as rates when looking at the ROI on an investment property. Investors should carefully take into account the amount of equity needed to purchase a multifamily asset—many times double the amount that would have been required a year ago—when calculating the return potential.
Be Strategic About Value-Add Projects
With the changing market fundamentals and rising interest rates, multifamily investors need to think strategically about value-add plays. This requires careful evaluation of the types of projects that can garner higher rents and maintain high occupancy rates. In some markets, economic and demographic trends may look promising for larger renovation projects that will attract tenants who can pay more. Conditions such as strong population and job growth must be present to support higher rents and demand for housing. To properly assess growth markets, detailed underwriting is necessary.
Choose a Partner with a History of Expertise
During times of economic uncertainty, value-add opportunities will continue to emerge. Not all operators have the expertise required to identify and maximize those deals. That’s why it’s essential to seek operators with a proven track record of good data and strong underwriting capabilities to evaluate growth markets. The right operator will be poised to drive results with multifamily value-add investments, even during times of market volatility.
Contact us to learn more about multifamily real estate investing with Lucern Capital Partners.