The value-add strategy involves purchasing a worn-out or underperforming property that has below-market rent rates, low occupancy rates, or low net operating income (NOI) ratios, and then renovating or improving it, with the expectation of higher rental income and asset appreciation after holding it for a short or medium-term period.
1) Profitability Ratio
To underwrite the value-add strategy, the most commonly used ratio is the return on investment (ROI) ratio.
ROI = Increased Revenue / Budget to Renovate
The ROI rate varies based on factors such as the extent of the renovation, location, and market trends. However, a threshold of 12% is typically considered for proceeding.
However, ROI does not consider the value of time. If the renovation execution period exceeds the average time, the actual return rate may not be attractive. Therefore, I suggest using a modified ROI, which calculates the average annual return over the investment horizon, including the renovation period.
Total Increased Revenue over the Holding Period(TIRoHP) = (Increased Rev x 50% x Renovatio Period) + (Increased Rev x Rest of the Holding Period)
Average Annual Increased Revenue(AAIR) = TIRoHP / Holding Period
Modified ROI = AAIR / Budget to Renovate
This simple metric can help make investment decisions on value-add opportunities. A double-digit modified ROI is typically considered a good mark for moving forward.
2) Budget
The total investment amount required for a value-add strategy is determined based on factors such as the depth of the renovation, the vintage of the property, and the class of property.
3) Execution Timing
Maintaining the current occupancy rate during the renovation period is crucial for a successful value-add strategy. Renovations will only be executed on vacant units. Estimating the total process period will be relatively easy based on the current vacancy rate.
(On the assumption, interior renovation to each unit takes one month)
100% / (current vacancy rate) X (period to renovate each unit) = # of months for total process
4) Type of Renovation
Renovations can be subcategorized into exterior and interior renovations. As interior renovations have a greater impact on a tenant's residential decision, most value-add projects tend to spend more on them.
a. Exterior: can be grouped into various purposes
Branding/Marketing
Signage ($100-300 per unit): More exposure to future tenants
Leasing Office ($100-300 per unit): Improve the first impression of an apartment
Model Unit ($15,000-$25,000 per model unit): Help potential tenants to visualize their residence (Staging costs $1 psf per month)
Amenity Improvement
Smart Locker ($500 per compartment): One of the must-items for apartments today (Smart Locker Room cost $0 to install but only monthly fee)
Pool Area ($200–$400 per unit): Upgrade pool furniture and deck
Fitness Center ($100–$200 per unit): By providing a great gym, an apartment will be able to increase rent by $50+
Dog Park ($100-$250 per unit)
Smart System ($500-$700 per unit): Smart doorlock/HVAC system connected via mobile app
BBQ Area ($100 per unit)
Wifi Lounge / Business Lounge / Gaming Lounge ($200+ psf)
Bike Rack Room ($50-$500 per bike)
Laundry Room ($100-$150 per unit): One washer&dryer set per 10 residential unit
Movie Room ($10,000-$50,000 total)
Wifi Fiber Options System
Community Environment
Parking Lot ($150-$400 per unit): Prevent non-residents from parking in the community
Painting ($200-$650 per unit)
Landscape ($150-$300 per unit): Irrigation / Tree Trim
Window ($200-$1,000 per unit)
Security Cameras ($100 per unit)
Gated Community (Fence ($15-40 per feet) + Security Gate Entrance System ($25,000+))
Hallway
Roof ($200-2,000 per unit): Replacing roof / deck / gutter
Additional Revenue Opportunity
Storage Unit ($25-40 per SF)Utilizing dead space, turning to an additional revenue opportunity
Over Car Bonnet Storage Unit ($1,100 per space)
Laundry Room ($100-150 per unit)
Parking Lot ($150-400 per unit)
Vending Machine ($1500-$8000 per machine)
Operational Improvement
Roof ($200-2,000 per unit): Replace roof/deck/gutter, preventing leakage and future burden
HVAC ($200-500 per unit
Plumbing ($250-350 per unit): Leakage/water heater/drainage
Retaining Wall: Preventing future natural hazards including landslide
Smart Valves ($1,000 per valve): Remove pockets of air from the water, preventing overcharge of water bill
Water Softener ($500 per unit): Turning hard water into soft
Solar Panel: Install solar panels for a tax credit
Parking Valet Service: Increase # of parking spaces and security of the community
Trash Valet Service
b. Interior
Washer & Dryer
Stackable ($800+ per set)
Separate ($1200+ per set)
Kitchen
Cabinet ($1.2+ per sf)
Countertop ($2.2+ psf)
Faucet ($400+ per sink)
Backsplash ($0.3+ psf)
Appliances ($2,000+ per unit)
Kitchen Island ($200-$4000 per island): Cart, base cabinet, or table
Bathroom ($800 total per bathroom)
Sink
Showerhead
Tub
Wallpaper
Towel Rack
Floor (General)
Carpet ($1-$3 psf): Cost-effective with efficient soundproofing and smell absorption
Vinyl or Linoleum($1.5-$7 psf): Affordable with low maintenance
Hardwood ($6-$12 psf): Beautiful, but possible moisture damage
Laminate ($2.7-$10 psf): Lower price than hardwood, but prone to moisture damage
Bamboo ($5.5-$12 psf): Moisture resistant
Cork ($5-$14 psf): Sound-blocking, fire-resistant
Terrazzo ($25-$90 psf)
Floor (Bathroom or Kitchen)
Marmoleum ($3.25-$9 psf)
Porcelain or Ceramic Tile Floor ($13.5-$83 psf)
General
Paint ($0.15+ psf)
Ceiling Fan ($150 per fan)
Door ($35+ per door)
Plumbing ($100+ per unit)
Fixtures ($350+ per set)
Mudroom Bench ($300+ per unit)
Smart System
Smart Home Package ($500-700 per unit)
Smart Door Lock ($100+ per unit)
c. Other Things to Consider
City Permit: Depending on the jurisdiction and the depth of the renovation, a permit may be required. If the property is a historical heritage, a permit may also be necessary.
Marketing Cost: Consider the cost of marketing the property once the renovation is complete.
Tenant Buyout: Depending on the jurisdiction, a tenant buyout may be necessary, with costs sometimes starting at $20,000 per unit.