Value-Add, the Recent Darling of Apartment Investors, Fades

Value-add has become a favorite strategy of apartment investors: buy older, suburban apartment complexes, polish them up and raise rents. It’s a tried-and-true way to capture bigger returns as top-of-class properties become too pricey.

But like so much else in the commercial real estate world, the coronavirus pandemic has thrown a huge monkey wrench into that system. The concept of upgrades and raising rent is now in doubt.

“I think it will be a while before we see any unit renovations,” said Michael Manelis of Equity Residential. Manelis, the chief operating officer at the big Chicago-based real estate investment trust, addressed the challenges of the value-add strategy in an online conversation with the National Multifamily Housing Council this week.

The problems are manifold, said Manelis. First off, even in cities not under a construction ban, many contractors are not willing to work in the close quarters of an occupied apartment. And residents are equally reticent to invite these workers in.

“Those people aren’t willing to come, and frankly the residents don’t want them there,” he said.

Worse still, many of the more than 36 million Americans who have lost their jobs since March when many states shut down their economies are renters.

“It’s unclear if those people are going to be willing to pay those rent premiums,” said Bob Hart, CEO of Los Angeles’ TruAmerica Multifamily, which specializes in value-add investments. “Generally, all that work is on hold,” Hart said during an earlier NMHC webinar.

The value-add strategy is a predictable part of the economic cycle. In the start of an economic upswing, big investors typically snatch up the swank new rentals in city downtowns. As those safe, profitable properties get snatched up, there is an opening: raise rents at older properties but still keep them cheaper than the downtown prizes.

According to CoStar data, investors poured more than $348 billion into value-add apartment deals between 2017 and 2019.

But Andrew Rybczynski, a managing consultant at CoStar, says value-add players may have even more risk these days than other apartment investors.

“All transactions are way down. The spread [in price] we saw value-add investors chasing was shrinking before the pandemic,” said Rybczynski this week. “And with rents declining, value-add would be chasing vanishing rent jumps. Based on what I looked at in our data, 2019 was already a weak year for value-add, relative to 2018, and I would think that an environment with unclear pricing would hurt the segment as well. Those guys need to be able to come in cheaper than comparable buildings with better occupancy or product. If that’s impossible to ascertain, they can’t price properly.”

Construction of new luxury apartments has continued apace this year. And those properties have their own problems as the unemployment rate soars.

But some investors are still putting faith in the value-add strategy. Even in the past three months, as the economic shutdown has thrown sales into a tailspin, value-add properties are being marketed, and some firms are buying.

At the start of May, CWS Partners of Newport Beach, California, put the 460-unit Marquis at the Parkway up for sale in Denver’s trendy Lincoln Park neighborhood. Completed in 1982, and within spitting distance of the new luxury high-rise apartment towers dotting Denver’s downtown, the property is a classic value-add investment. A new owner could buff up the interiors and improve the amenities to raise rents. Real estate professionals estimate it should be worth $115 million, or a cool $250,000 a unit. The new rules about valuation will have a say, though, no doubt.

In San Francisco, three separate buyers recently shelled out $160 million for 272 units in need of some loving care. San Francisco-based Mosser Cos., a value-add multifamily firm, bought the biggest chunk of the portfolio for $90 million and is looking to upgrade units and raise rents.

That strategy may be past due, though. “It's just going to be hard jacking up rents like we’ve done before, right now,” said Manelis of EQR.