You have acquired a new community and now it’s time to renovate. Problem is, several challenges have arisen. Occupancy numbers had been exaggerated by the seller and you’ve underestimated the rehab costs. Your timeline for completion is unattainable, as well.
Hopefully none of these hurdles have plagued your company’s efforts, but numerous renovation hazards exist and it’s easy to learn the hard way. Fortunately, there are several tactics to help prevent these, and other potential obstacles, from curtailing the value-add process.
One general recommendation is to use some form of due-diligence software. It can be easy to glaze over how much work is needed simply due to the raw size of the project. The software enables due-diligence teams to take notes on a per-unit basis about the condition of the apartment home, needed repairs, color and age of appliances and the functionality of water heaters and HVAC systems.
If it takes a week to go through the evaluation process, you can pull a comprehensive report that provides better visibility into how much work actually needs to be done. That allows you to adjust the budget based on the value-add needs.
With that in mind, here are a few renovation hazards and potential approaches to avoid them:
Lack of seller transparency and limited building access
When on the market to acquire a value-add property, you might not have the luxury of seeing everything. No standardized access exists, and the amount of access you have varies depending on the owner and the competitiveness of the transaction. It can vary based on your partner and their expectations.
Some owners won’t let you open up a wall to determine if any issues are present, while other owners offer limited inspection areas. You want to know whether the community you’re soon to acquire has moisture behind the wall or even termite issues. Often when owners give you the option to look, it’s usually not as bad as you think and the examination allows you to quantify the areas of damage and potential renovation costs.
You generally have to give a reason as to why you’d like to examine an area, which is fair. If the seller won’t provide access, you have to think worst-case scenario. Overall, it’s important to strike a balance. Many companies looking to acquire a community are sellers themselves, so consider the amount of transparency that you would allow if the tables were turned.
Sellers naturally want to report robust occupancy numbers. Sometimes those numbers, however, can be deceiving. Occupancy rates can be padded with short-term leases, concessions or lack of financial guidelines and credit standards.
That’s something to be keenly aware of during the lease-audit portion of the due-diligence process. Unlike building access, full transparency is granted here. Short-term leases are a red-flag item in that occupancy is soon to take a hit. With housing near universities, for instance, if leases are expiring after peak leasing season it can definitely have a detrimental effect on your long-term occupancy.
Acquisition teams should be adept at identifying these items of concern, because it will readily become apparent if the previous owner didn’t take resident demographics into account. If any of these occupancy issues are apparent, prepare for a residency hit on the front side and of the acquisition and factor it into your decision of whether to move forward with the transaction.
Budget forecasts and cost constraints
Nailing a renovation budget is a lofty ambition and a generally unattainable one, and the likelihood can vary based on the scope of the renovation.
No matter the scope of your renovation, standardizing products can help you meet your budget. Even if your portfolio ranges from Class A to Class C, many components of the renovation will be the same. A few tweaks in the standardization will occur, naturally, such as the use of higher-end plumbing fixtures at the Class-A properties. But by standardizing items such as cabinets and flooring, you can measure the size of the individual units and already know how much it will cost to renovate them.
That’s not accounting for unforeseen obstacles, such as subfloor issues, so it’s recommended to install a miscellaneous cost item into your budget number. When accounting for miscellaneous expenses, it’s even more difficult to nail a budget. Some companies bring in contractors to construct a renovation estimate. The contractors might see something you could have missed.
It’s a fluid process, but renovation teams should be trying to value-engineer at the beginning. In the case of an acquisition, you can bid out the project to multiple contractors to try to save a few hundred thousand dollars. Those saved funds can be applied toward unexpected expenses, such as the need to upgrade electrical service in a clubhouse, because it’s not up to code after the renovation.
Timelines are the most wavering entity in the real-estate world, and renovation projects are no exception. It’s less challenging to construct a reliable timeline for in-unit upgrades. As for the remainder of the renovation, it’s recommended to provide your investors with a wider range. The lack of quality skilled labor is making it even more difficult to set precise timelines. Therefore, it’s best to manage the expectations of your investors and construct a more manageable timeline based on the current construction environment.
Obtaining permits is also becoming more difficult, as certain jurisdictions don’t have the resources to quickly navigate the review process. Other markets simply have a high volume of requests.
It is yet another potential obstacle in the renovation process. But if you are aware of these hurdles going in and have a plan to overcome them, the process will progress that much more smoothly.
Chris Pilato is the vice president of Construction and Development for CAPREIT.