The 5 Basic Phases Of Value-Add Multifamily Real Estate Syndications

If you’re new to real estate syndication or just learning about this investment strategy, value-add investing can be overwhelming. However, it offers more than just acquiring properties and hoping for appreciation over time. Instead, it allows investors to take calculated risks and pursue renovations that add value to the asset, eventually leading to increased rents and property value.

Value-add investments are often performed on multi-unit properties, which can make renovations quite complicated. However, this investment strategy involves adding value to the property one unit at a time in a structured way that minimizes the impact on occupancy rates.

To better understand this process, let’s use an analogy. It’s like when you first learned about the five-paragraph essay in elementary school. Prior to this, writing focused on correct spelling, capitalization, and punctuation. But the five-paragraph essay introduced a framework for organizing thoughts around a central idea, expanding on it with supporting paragraphs, and closing with a strong conclusion.

Similarly, value-add investments follow a structured approach to adding value to a property. It starts with identifying the central idea, which is typically an underperforming property with untapped potential. The next step involves developing a plan for improvements that will add value, which may include renovating units, improving amenities, or upgrading the property’s infrastructure.

The third step is executing the plan, which is done carefully to minimize disruptions to tenants and maintain occupancy rates. Finally, the property is repositioned for sale, which can result in significant returns on investment. While value-add investing may involve more risk, it can offer higher rewards for those willing to take on the challenge.

Similar to how the five-paragraph essay provides structure and freedom to communicate clearly and effectively, the value-add investment strategy used by successful real estate investors provides a framework for adding value to an investment property in a controlled effort to increase its worth. By taking on more risk and performing renovations one unit at a time, investors can add value to the property without affecting occupancy rates significantly.

Breaking Down One Of The Most Lucrative Real Estate Investment Strategies: Value-Add Multifamily Syndication

Value add real estate syndication, similar to a five-paragraph essay, goes through a logical progression of stages that provide structure and clarity to the investment process. Though the structure may vary, a well-executed value-add project should have a clear beginning, middle, and end.

Unlike investing in stocks or mutual funds, syndication involves pooling resources together with other multifamily investors, making it crucial for everyone to be on the same page for the investment to be successful. This emphasizes the importance of having a clear business plan for value-add investments.

In this article, we will examine the five most common phases of a value-add multifamily real estate syndication. By following these stages, investors can mitigate risk, add value to the property, and ultimately increase returns.

1. Acquire

2. Add value

3. Refinance

4. Hold

5. Sell

 Phase 1 – Acquire Commercial Real Estate

The first stage of this opportunistic investment strategy is the acquisition of the asset. During this phase, a bunch of things happen. It’s a busy and exciting time for the syndication, as this phase sets the entire investment on the right foundation.

Buy Property

The acquisition phase is a critical component of any real estate strategy. It involves securing a valuable property under contract, which can often be a challenging task due to the competitive nature of the real estate market. Sponsors must be skilled and knowledgeable in various aspects of real estate to succeed in this phase.

To start with, sponsors need to establish strong relationships with real estate brokers in their market to access the best deals. They also need to have impeccable underwriting skills to quickly evaluate whether a deal is worth pursuing or not. This involves analyzing various aspects of the property, such as its location, condition, and potential for value-add opportunities.

Additionally, sponsors need to have strong relationships with lenders and property managers to confirm their underwriting assumptions and determine whether their target projections are achievable. By working closely with these stakeholders, sponsors can mitigate risk and make informed decisions about which properties to pursue, ensuring a successful acquisition phase.

Perform Due Diligence

After securing the property under contract, sponsors move on to the due diligence stage, which is a critical part of the real estate strategy. During this phase, sponsors must conduct a comprehensive and meticulous examination of the property to identify any potential issues that could impact the investment.

This process involves a detailed analysis of the property’s physical condition, financial statements, legal documentation, and other relevant factors. Sponsors must leave no stone unturned to uncover any potential risks or liabilities that could affect the property’s value or the success of the investment.

Based on the findings from the due diligence, sponsors may need to adjust their business plan and update their assumptions to ensure that their projections still work. By conducting a thorough due diligence process, sponsors can make informed decisions about whether to proceed with the investment or renegotiate the terms of the contract.

Find Investors

Once sponsors have completed the due diligence stage and confirmed that the value-add property is a viable investment, they can begin offering the opportunity to potential investors. This is a crucial step in the real estate strategy, as it enables sponsors to secure the necessary funding to execute their business plan.

To attract investors, sponsors typically send out a new deal alert and an investment summary that provides all the pertinent details about the property and the investment opportunity. This information helps investors evaluate the potential risks and returns of the investment and decide whether they want to commit capital to the deal.

To further educate investors, sponsors may also host an investor webinar, which provides a forum for sponsors to present the property’s untapped potential and answer any questions that investors may have. Once commitments are made, and funds are wired in, the deal is ready to close, and the sponsors can celebrate their success.

Overall, the process of opening the investment opportunity to potential investors requires sponsors to effectively communicate the value of the property and the investment opportunity. By doing so, they can secure the necessary funding to execute their business plan and create value for all stakeholders involved in the transaction.

Phase 2 – Real Estate Value Add Process

The value-add multifamily real estate syndication involves a phase where value is added to the investment property. This phase is critical as it enables the sponsors to execute their business plan and create value for the investors. In most cases, the business plan calls for the renovations to begin immediately after closing the deal.

The first step in this phase is to transition the property management team if needed. The operational enhancements are often the quick-win solutions to reduce operational expenses, increase efficiency, and boost the property’s net income. Once the operational enhancements are in place, the renovation of the vacant units can begin.

The renovation process may also include exterior and common area renovations such as adding a dog park, updating light fixtures, cleaning up the landscaping, sprucing up the pool area, and adding covered parking. The renovations are tailored to the property and the business plan, and they can take a few months to a few years to complete.

In heavy value-add investments where most, if not all, the units need updating, the unit renovations can take 12 to 18 months or longer. The renovation process starts with the vacant units, and as the leases come due, tenants have the option to move into the freshly renovated units at market rents. Renovations continue in the units vacated by tenants until all the units are updated.

As the renovations progress, the sponsors monitor the progress and adjust the business plan as necessary. The goal is to create a property that attracts quality tenants and generates strong cash flow. Once the renovation process is complete, the property is in a better position to command higher rents and generate better returns for the investors. Overall, the value-add phase is a critical part of the real estate strategy, and it requires meticulous planning and execution to achieve success.

Phase 3 – Refinance If It Benefits the Real Estate Investors

After completing the planned updates and renovations, the hope is that the investment property is now producing substantially higher revenue. This outcome represents a significant achievement in the real estate strategy and marks a key milestone in the investment process.

How Commercial Assets Are Valued

It is essential to remember the difference between evaluating the value of a single-family home versus an apartment building. While comps are used to assess the value of a single-family home, the valuation of a commercial asset is based on the income generated by the property. Hence, higher rents increase the value of the property significantly.

In value-add properties, renovations can increase the rent premiums of the units. For example, while an existing unit might rent for $800, a renovated unit could potentially fetch $900 in rent. Although a $100 difference may not appear significant, the impact can be significant when applied across a multi-unit property.

To illustrate this point, consider a complex with 100 units. A $100 increase in monthly rent across all units equates to an additional $120,000 in rental income per year. This additional revenue can then be used to increase the equity value of the property through underwriting and cap rate manipulation.

Thus, when value is added to the property by renovating and upgrading units, it can lead to a significant increase in rental income and equity value. This increase in value is not solely limited to the renovated units but can be applied across the entire property, thereby maximizing the overall investment returns.

Aim to Refinance

As cash flow starts to increase and the majority of the value is added to the property, sponsors often consider a refinance. In the case of value-add real estate, refinancing is usually done through a supplemental loan, keeping the original loan in place unless interest rates are lower than when the property was acquired.

As the property’s new revenue potential is evaluated, it will likely receive a higher appraisal value. This new equity can be used to secure a supplemental loan, and investors can expect to receive a portion of their original capital back.

For example, suppose an investor has invested $100,000 in a value-add multifamily syndication, and the sponsors refinance the property and return 40 percent of the investor’s capital after 18 months. In that case, the investor will receive $40,000 of their original capital back.

Even after receiving $40,000 back, investors continue to receive cash flow distributions as if their entire $100,000 was still invested. So investors get their money back and continue to receive eight to ten percent of their $100,000 per year in cash-on-cash returns.

Refinances Are Not Guaranteed

The potential for a refinance is a key advantage of a value-add investment. However, it is not a guaranteed outcome and may not even be discussed in the original business plan. The decision to refinance or sell depends on various factors, such as market conditions and investor interest.

If a refinance or sale does occur, it can be cause for celebration. However, investors should also consider the potential tax implications and decide whether they want to reinvest the returned capital or exit the investment entirely. Ultimately, a successful value-add investment requires careful planning, execution, and flexibility to adapt to changing market conditions.

Phase 4 – Holding Period

After the refinance or sale, the final phase of a value-add multifamily real estate syndication involves holding onto the value-added property and collecting cash-on-cash returns. The duration of this phase varies depending on several factors such as the property, sponsor, and business plan.

Many value-add investments have a projected hold period of around 5 years from the time of acquisition to the final sale. However, this timeframe is not set in stone and can be shorter or longer based on the specifics of the investment.

During this phase, investors continue to receive cash flow returns based on their investment, providing a steady source of passive income.

Stay the Course

During this phase, the risk involved in the value-add multifamily real estate syndication is at its lowest point. The challenging task of renovating the property and adding value has been completed, and there are fewer unknown factors to consider. The main objective at this point is to maintain the property’s trajectory by expanding the tenant base, seeking methods to increase the net operating income, and sustaining the cash flow to produce substantial revenue.

Continued Appreciation

During the holding period, the value-add multifamily real estate asset is expected to appreciate in value, but at a slower rate compared to the renovation phase. It’s common for rents to be increased by two to three percent annually, leading to a gradual rise in revenue and overall appreciation of the property. This appreciation happens naturally over time, without the need for any additional value-add activities.

Phase 5 – Sell To Complete The Full Cycle

The value-add multifamily real estate syndication culminates in the final phase, which involves selling the asset. By this point, the intended updates and renovations have been completed, generating increased revenues and appreciating the asset’s value.

Why Sell

Instead of holding onto the asset indefinitely, the optimal strategy for real estate investors is to sell the property and use the proceeds to invest in another project, thereby maximizing returns on their capital.

Disposition Process

During the disposition phase, sponsors collaborate with the property management team and real estate broker to get the asset ready for sale. They may decide to sell the property off-market to avoid disrupting the existing tenants or list it through the usual process, which can be a lot of work.

When the sale is completed, investors receive their initial capital along with a portion of the profits.

1031 Exchange

When a value-add multifamily real estate syndication reaches its final phase, sponsors may choose to initiate a 1031 exchange in certain situations. This enables them to roll the proceeds from the sale into a new investment without paying capital gains taxes.

For real estate investors, this is an opportunity to keep their money invested with the same sponsor in a new value-add real estate deal. Some investors have repeated this process with a single sponsor through multiple cycles, and have found it to be a highly successful strategy.

What A Value Add Real Estate Investment Strategy Really Means

The five phases of a value-add real estate syndication provide a framework for investors and sponsors alike to understand the investment process and stay focused on achieving the investment goals. Similar to a five-paragraph essay, each phase serves a purpose and contributes to the overall success of the investment.

Throughout the holding period of a value-add real estate syndication, the property undergoes these five distinct phases: acquisition, value-add renovations, stabilization, holding, and disposition. By following this structured approach, sponsors can ensure that the investment stays on track, and investors can have a clear understanding of what to expect.

1. Acquire

2. Add value

3. Refinance

4. Hold

5. Sell

It’s important to note that not all value-add properties will go through all five phases. However, this is a widely used structure by many value-add multifamily syndicators.

As an investor, it’s not required for you to take any action during these phases. Nonetheless, it’s crucial for you to comprehend the trajectory of value-add real estate so that you can anticipate what’s to come and ensure that the sponsors have a clear strategy for the property and your investment. This knowledge can help safeguard your hard-earned money