Apartment Value Add: Interior Renovations

“Proven Value-Add! 20% of the units have been renovated and are achieving $250 premiums,” the broker’s email blast reads. After a cursory search reveals the apartment community is in a desirable area with decent schools and a strong single-family housing stock, it is time to take a deeper dive into the opportunity.  Upon executing the confidentiality agreement, we download the investment package and start flipping through the offering memorandum.

It seems like a clean, 1990’s vintage deal – new roofs, exteriors were painted recently, and the clubhouse was renovated. The remaining meat left on the “value-add bone” seems to be the 80% of the units that weren’t renovated.

Yikes, the renovation package leaves a lot to be desired of. Are they really achieving $250 premiums? Black appliances would have been popular 10 years ago. Opening the rent roll shows that approximately 20% of the units are noted as “renovated” and leased at a rate that is around $250 higher than the standard unrenovated units. They are getting pretty big premiums in spite of their ancient finishes. That is a good sign. The standard units have oak cabinets and white appliances so we can definitely do better.

The ceilings are 8 feet high which is surprising given the 1990’s vintage. It looks like the newer comps are $400 above the subject property’s standard rates but the newer deals all have 9 foot ceilings. As a result, the post-renovation rents will also have a “ceiling” that will be tied to deals with 8 foot ceilings. Fortunately, renovated units at the competing communities with 8 foot ceilings seem to be getting $250-$300 per month higher than the subject property. This makes sense given the success the current owner has had with their value add program. Maybe we can proforma $275 premiums and achieve $300 per month since we will have more attractive finishes and a better property management company running the community.

In addition to being 8 feet tall, the ceilings are also textured. “Textured” is a nice way to say they are “popcorn” ceilings. It would look much nicer if we drywalled across the ceilings for a smooth finish but we will not be compensated for this work via an increase in rents. We will have to save the drywall finish for your dining room, not the value add apartment deal we are pursuing.

Are there washer/dryer sets in the units? It doesn’t look like it but there are washer/dryer connections in place ready to go. The comps charge $40 per month extra for washer/dryer sets. We know we can buy washer/dryer sets for $700 so think about the ROI at $480 per year in additional premiums!

We can start to develop a scope after reviewing the renovation packages of the competing properties.  In order to compete, we should do vinyl plank flooring in the entryways, kitchen, living room area, and bathroom. Most of the time you can get away with using carpet in the living areas but this demographic seems to command new plank flooring throughout. These areas will also get a new attractive two tone paint scheme. We will refresh the bedroom with new carpet and paint.

The kitchen will need a new countertop but granite will cost too much for this renovation package. Remember, the property will never be a Class AAA community. This community will be a solid B+ asset when we are done but we won’t be compensated with extra rent premiums for installing granite. There are a lot of attractive and economical laminate options available and all the comps seem to have laminate countertops.

The comps all have stainless steel appliances in their kitchens. Stainless steel is more attractive and popular than black appliances. Stainless has also come down in price in recent years. We can probably buy the entirestainless steel kitchen suite for $2,000. Stainless is a no brainer here.

The next decision comes to the cabinets. Once again, we will never recoup our investment by fitting these units out with high end custom cabinets. The cabinets need to look nice but this isn’t a $30,000 kitchen. I know we can get nice cabinets for a kitchen this size for around $1,800. That sounds good but it would be better if we could find a more economical option. The subject’s cabinets seem like they are in good shape. The property was built in the mid-1990’s so it’s not like the cabinets are 50 years old. Perhaps we could paint the cabinets white and install new hardware. This route would cost about a third of the price tag for brand new cabinets. We will have to see what condition the boxes and cabinet faces are in during our site visit. It would be sweet to get away with just painting them as that would really enhance the returns.

The bathroom will also need a facelift so we can achieve our premiums. In addition to new vinyl plank flooring, the bathroom will receive a new vanity and sink. We can get an attractive, but economical, plumbing/lighting fixture package for under $500 that will handle both the bathroom and kitchen. A new framed mirror, low-flow toilet, and brushed nickel toilet paper holder will finish off the newly renovated bathroom. The low-flow toilet is environmentally friendly and will provide a return on investment by reducing water consumption.

Let’s be conservative and assume we replace the cabinets rather than painting them. This brings our entire renovation budget to approximately $12,000. This budget number will vary by unit type as two bedrooms units will cost more than one bedroom units since there will be more flooring and painting. If a unit has multiple bathrooms then we must adjust our budget for that too. For quick, back of the envelope purposes, we will assume the average unit will cost $12,000 and achieve a $250 premium.

We project a total of $3,000 in revenue from each additional unit by taking the $250 per month premium and multiplying it by 12 months. We know this will be accretive to the deal just from the fact that it yields a 25% cash-on-cash return ($3,000 premium / $12,000 cost). Cap rates in this market are hovering around 6% so we can also quantify the value created by renovating the units. Taking $3,000 and dividing it by 6%, “capping it”, we determine that the renovations add $50,000 in value for each unit that is renovated.

We can determine the renovation program’s IRR by getting all of this into Excel. Using the IRR function, we can see the renovation program throws off a 43% IRR. At these levels, I know the renovations will be accretive to the deal without even fully underwriting the opportunity.

What if we renovate 100 units? How much value will we create?

($250 premium x 12 months x 100 units) / 6% cap rate is equal to $5 million in value creation.

We like that a lot. It is time to book our flight so we can this deal in person.


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