The Battle Between Value-Add and High Yield Properties

The Battle Between Value-Add and High Yield Properties | The Kitti Sisters

030:  The Battle Between Value-Add and High Yield Properties

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We’re starting today thinking through two different strategies when it comes to learning all things apartment syndication and real estate terminology. 

Nancy learned by trial by error and said, “Okay so when I was learning about all of this terminology with apartment syndication and investing, I learned by osmosis. You remember how inducted into the system we were to learn all things real estate! I mean, we were lowkey obsessed. So what I’m saying is that I think if you’re new to this world– the only way to fully understand everything is baptism by fire.” 🔥

And I, Palmy, learned all of the lingo through 📖 books and reading up on all of these definitions. Real estate is a very big world, and reading books from the experts before us really helped me gain confidence. I was a little too nervous to jump in head first with all of these investors and their insider lingo. I felt like such a small fish in a big pond!

Regardless if you learn by jumping into the deep end, or studying the pool before assessing if you’re going in or not– the wonderful world of real estate and apartment syndication can be a lot for one person to learn. So many new phrases, and so little time! ⏳

It’s no secret that apartment investing comes with its fair share of decisions to make, terminology to understand, and strategies to digest. On top of all of that, how we make money as apartment investors can vary depending on the business strategy and its execution on each deal. 

But do you know what’s different about you, fellow apartment investor? You’re not like the other guys. You listen to this podcast and do your own due diligence and that’s how we know you’re a savvy passive investor. And those traits are crucial to understanding what you’re getting into when deciding how and when you’re going to invest. Once you understand how the sponsor team plans to generate cash flow, you can invest confidently.  

That’s why today we’re introducing two new phrases for two types of apartment investments.  Value-add deals and yield play deals.

We made a promise early before we fully launched this podcast, our blog, or Instagram, that our goal was to help everyday people invest confidently in a way that will help you make progress towards securing your financial futures. And knowing the difference between value-add yield play strategies will help you with that confidence. 

Today we’re breaking down these two terminologies and how they’re different, how they’re similar, and how we put our own spin on things, so you can make smart investing decisions for wherever you are in your journey.

Value Add Approach 

Let’s start with a value-add deal. Before we let you in on the official definition, take your own stab at what you think it might mean. If you’re thinking anything along the lines of adding value to a property, you’re on the right track! 

A value-add deal is exactly what it sounds like – adding value to a property in order to raise the net operating income. Using the value-add method, apartment property owners typically focus their business plans on some sort of rehab that increases the property’s appeal, justifies a rent increase, and ultimately increases the property’s value. Basically, it’s the apartment owner’s job to give the place a glow-up in order to secure a higher NOI– net operating income.

The value-add strategy is often executed on properties that are classified as B or C class because these properties have more opportunities for improvement. Why not class A properties? Because typically class A properties are at their prime and there really isn’t much to improve there. 

Don’t mess with perfection, you know? If you are new here, check out EP025 Stay Classy: The Grading Scale of Apartments where we go into details of different classes in 🏢 apartments.

So while adding value is one thing, how to add value both within the individual units and in the common areas of the property itself (think, the lobby, pool, parking space) are usually through a little TLC. This is where a little elbow grease and a sledgehammer come in handy. Rehab to units might include replacing flooring, updating countertops, re-painting walls, and upgrading appliances. Value-add renovations that can improve the overall property might include building a playground, creating a dog run, or making parking spaces covered. 

Here’s the other secret to know about value-add properties– sometimes you don’t need to break out a hammer at all. Enter “re-marketing”, a common phrase used by investors to increase the desirability of a multifamily building. 

Ultimately, creating a safer, more convenient, and more enjoyable atmosphere for residents adds value to their lives while helping operators create more value in the property. 

In a previous post, we have also talked about making sure that the way this is executed comes with a lot of history and understanding of the area you’re investing in and how you’re making those changes to re-tenant (or re-market) to certain demographics. 

Whether your plan involves rehabbing, installing new amenities, re-tenanting, or a combination of the three, adding value to multifamily housing involves proper planning and execution. There are definitely no shortcuts here. 

Value-add methods are often considered riskier as more work and planning are involved. This strategy also makes the property attractive for future buyers as long as you leave enough  “meat on the bones” or room for the next owner to continue to increase NOI. By that we simply mean don’t have all of your units be looking too good, you want other investors in the future to have their Cinderella moment too! 

Recently we had an exciting turn of events when we were able to go full cycle without any renovation on a property. 😵😵 Full cycle means to exit the property. So even though we had told our passive investors that we budgeted for a rehab cost in our proposed business plan, we were able to organically increase our rent without any renovation. 

And for those of you keeping score at home, yep, this means more profit back to our passive investors. This actually brings up a good point for your sponsorship teams in the future. Make sure they have explicitly shared what projects they will be executing at the property, including how many units will be renovated and a reasonable budget to complete the projects. 

This will allow you as a passive investor to understand the value that will be created and if they have thought through how they plan to make money while they own the building but also their exit strategy when it comes time to sell.

It’s all fun and games until you need to exit the property‼️

High Yield Approach 

Okay, let’s move on to the high yield approach. As we just learned with value-add properties, those heavily live in the land of class B and C properties. So for our high yield approach friends, those guys mainly deal with Class A properties. I mean, you wouldn’t–or couldn’t– add value to a masterpiece already, right?

Could you even imagine someone looking up at the ceiling in the Sistine Chapel and say out loud: “I mean, it’s nice but I can probably do better.” 😗😗

You simply don’t mess with a good thing, and that’s where the term high yield approach comes to play. The high yield comes from the concept that the property is “yielding” a cash flow when you purchase it. 

Typically on these properties, major rehab has already been done so investors are buying it with the intention to hold on to the property and let its cash flow. They may make minor changes like upgrading utilities to high-speed fiber optic cable or focus on reducing operating expenses to drive additional value. These properties are already on their way up so there’s no reason to try to make any major changes.

The bonus with yield play deals, as they are also sometimes referred to, is that they are also typically seen as lower-risk investments because they do not require the same level of complexity as managing a deep renovation on multiple units as you might see in a value-add investment. 

But don’t let the glimmer in your eye of just investing in high yield apartments keep you distracted. You don’t want to sleep on the power of the value-add project. The sponsorship team can still increase the NOI by lowering expenses and keeping on top of market rents. 

Think of it this way, as two girls who were once in fashion, you need the vintage and the Spring/Summer pieces as well to have a well-rounded wardrobe. 😆😆 And the same can be said for the apartments you invest in. Having some yield play deals in your portfolio is an excellent way to offset the risk that can come with value-add projects.

Although the physical changes to the property for a Class A will be minimal after the purchase, since the asset is newer, the property’s value can still be increased. And just like keeping the tags on any dress you purchase, you know, just in case, Class A properties can also provide stable cash flow from the onset if, as a passive investor, your financial goals are more focused on cash flow vs. building wealth through large equity gains.

Hybrid Approach 

So now let’s talk to our people who are always walking the line on decisions like these. You know the type, they take about 30 minutes to choose what they want for dinner and are always asking people what they got to compare meals. They may also be using that fork a little too liberally as they test taste around the table. They just want to make sure they’re not missing out on anything!

For those people– and hey, no judgment here– we recommend the hybrid approach.  🤟

It’s not always an all-or-nothing situation when it comes to deals. Many sponsorship teams may choose an approach that combines both of these strategies–a high yield and a value-add approach. There doesn’t have to be a hard line in the sand separating value-add from yield play deals. Many investors look to find a multifamily apartment that already has a decent yield then execute smaller scope value-add projects to increase the current NOI and overall property value. 

You may see business plans that combine these two strategies in various ways. Owners will purchase a property that requires a moderate amount of value-add to yield additional cash flow, then use a cash-out refinance, continuing to hold the property but using the money to purchase another multifamily building. The original property becomes their “cash flow cow” while moving on to the next value-add deal, rinsing and repeating the cycle. 

Now that would satisfy anyone’s appetite. Especially if they order at least two appetizers.

Typical Returns

Now let’s get into the good stuff and talk about the typical returns from both yield and value add that we see in our apartment syndication investments.

We know the bottom line sometimes is the only line that matters.

Cash flow which is distributed month or quarterly depending on the investment generally will spit out 6 to 8% annually.  For example, if someone invested $100,000 they may receive $6,000 to $8,000 annually as part of their cash flow.  And assuming the investment has a 5-year hold, then the cash flow total would be $30,000 to $40,000. 🤍

The rest of the profit will come from the value-add portion.  When we talk about value-add, some may think about their experiences in single-family home flipping, where people celebrate winning the bid for a crusty dusty house with 30 years of old cat litter that has been stored in bins.  And yes, we’re speaking from experience from our flipping days. My dear sister Nancy has sent me to do due diligence in many homes like this.  Trust us, getting rid of the stench is not easy. This is not the type of value-added apartment we like to purchase.

And look, we’re not in the business of talking crap– pun intended. There are investors who love this stuff and buy vacant homes all the time because the thrill of ripping out walls and blowing up ceilings is what keeps them going. There are whole television shows dedicated to revamping. And while we always respect the hustle, that’s simply not our cup of tea. 🍵

You see those types of heavy or deep value-add properties come with a much higher risk.  For one, most of the types of properties you own you have to start from scratch, meaning you’ll need most if not the entire complex to be vacant.  This means no income during the rehab phase at all. No tenants helping to front the bill. And unless they are extremely experienced and know exactly what the sub-market residents are looking for, they may or may not be able to achieve their target rent or occupancy. 

But, There’s Another Way 

Now, if you’re wondering: Are these my only options? We’re here to tell you, there’s another way. For us, the Kitti Sisters, we live life with the spirit that we can have both.  Like a scoop of vanilla ice cream 🍦 with toppings consisting of strawberry syrup, soft mochi, peanuts, and of course a cherry on top!

So, maybe a little bit more than two toppings, but you get the idea! 

Depending on the deal structure and how long the holding period is, we may decide to invest in deals with some cash flow plus a huge upside upon the property’s sale. Or in the case of new construction, we’ll opt for a massive upside with a slightly delayed gratification of yield play once the property’s construction is completed and is fully leased up. See, we can have both worlds.  

And all of the ice cream our hearts desire. ❤️❤️

 Although we can have the best of both worlds, we do prefer to work with what are called light value-add properties. This means the property should already have strong occupancy, above 90%. Instead of targeting properties based on how much it smells  we focus on seeing value-add possibilities via below-market rents or occupancy rates. Take this as another example. Perhaps the property is in fairly good condition; however, it could also double as a set for a period piece TV show 📺. Think of your great aunt’s linoleum flooring or green shag carpet in your grandma’s den. I mean technically there’s a floor, but is it one you want to look at? While structurally there may be nothing wrong with the property, it lacks the modern touch and sizzle factor to attract new renters willing to pay a premium.  

Another type of value you add is improving the management of the property.  A lot of times we like to check out the google reviews of properties we are looking to purchase to read what the management team has done probably not the best and see if those are things we can improve.  That’s just a quick ninja tip for us, you’re welcome.

Here are some things we may elect to do to force appreciation on a light value-add property.

We may rebrand the property, bring on a new property management team, perform interior and exterior upgrades, switch out vendors, reduce operational expenses, and add amenities. Think Amazon lockers, cable/ internet packages, covered or reserved parking, install gates, cameras, you get the idea. Just enough to get people interested without breaking the bank. Or adding too much value.

As you may notice almost all of the light value add items we’ve listed can be done while the property’s occupancy is 90% or higher.  Except for the interior upgrades which are done on the unit turn, aka when someone leased the property and it’s vacant, we’ll tackle the interior upgrades. This means the property will still generate income while we complete our business plan. Hence, reducing downside risk.

So Now You Decide– What Toppings Do You Want? 

First, decide what season in your investment horizon you are in.  Do you have a solid active income via your business or W-2 that can support your lifestyle while you grow your empire via passive apartment investing? Or do you need the cash flow to supplement your living now?  Don’t worry, we can help with this. Use our Financial Freedom Calculator to help you figure this out!

Second, figure out your personal risk tolerance level. Are you a thrill skiller, backflip over water, stunt double who doesn’t mind investing in heavy or deep value add? Or would you prefer a more conservative approach that allows the property to still provide amazing returns but less risky. And please notice the key phrase we just said friends 👉 less risky not, no risk. With any investment opportunity, there will be risks. So anyone who can promise you that there’s an investment without risk– run.

But seriously, any investment comes with risks, but the risk can be mitigated by understanding the investment opportunity and working with an experienced team that has your best interests at heart.

Last thing to consider, pick a team that you’ll work with and learn what type of investment strategy their portfolio focuses on. Does the team have experience in heavy/ deep value-add or is their investment opportunity you are investing in their first go at it?  It’s probably best to go with someone who has experience and not someone who’s learning on the job with your money.

I mean, you wouldn’t ask an intern to be the CEO would ya? 🤔🤔

You Can Have All of the Toppings

The best part to all of this, whether you go the high yield approach or lean towards value-add deals is that you’re an adult now who can go to the ice cream shop and pick out as many toppings as you want! 

So let’s review, shall we?

Value-add deals offer endless possibilities for a higher return on investment but also bring a higher risk component. Yield play deals are great ways to create a straightforward and consistent income stream with a low-risk factor. Smart investors typically own portfolios with a mix of different approaches that are best tailored to each property. A diverse multifamily investment portfolio will allow you to grow your wealth while reducing risks along the way. 

What’s most important is to understand which approach the deal you are investing in is using, ensure the operator has a clear business plan that makes sense for the property, and evaluate how the deal fits into your own investment strategy and will contribute to your financial goals. ✨

But above all? Being equipped with the confidence that you got this and you have nothing standing in your way. We’re here for you no matter what!

 


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We're Palmy ➕ Nancy Kitti 〰️ The Kitti Sisters

A sister duo team obsessed with all things financial freedom, passive income, and apartment investing + apartment syndication, who turned a $2,000 bank account into a nine-figure empire.  Now, we're sharing with you the behind-the-scenes secrets of our wealth building strategy.

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