Market Dominating Makeovers

Successful repositioning spends the right amount in the right places.

Multifamily continues to be the darling of commercial real estate with sky-high rents and incredibly low vacancies. New Class A developments are raising rent ceilings to new heights. At this point in the cycle, it is hard to find trophy assets for sale at a reasonable price, with top markets already surpassing their pre-recession peaks when it comes to asset valuation. But investors will continue to invest, and some of the savviest are turning to Class B and C communities and making strong repositioning plays. The results can give new luxury properties a run for their money if done right.

“With the amount of institutional money out there for multifamily housing—especially on the East and West Coasts, and in Chicago and Texas—owners are taking advantage of the low cost of money and are choosing to reposition the whole property at once,” says Michael Binette, vice president and principal at Massachusetts-based The Architectural Team. “They might incorporate $30,000 to $50,000 per unit in improvements and either keep the asset with improved rents or turn and sell it to the institutional money.”

Binette has been involved in hundreds of developments and is experienced with breathing life into less than perfect multifamily communities. He advises owners and investors looking to make a repositioning play to take a step back and look at all potential improvements.

“Our initial task, despite knowing that there is a fixed budget to what these improvements will cover, is really looking at the project holistically,” Binette says. “We look at everything we can do to improve curb appeal, marketability and sustainability. Then we prioritize.”

Maintenance and operational improvements, while costly, do add value and they also can drastically reduce operating costs in older properties, where units are usually not submetered and energy costs are borne by the owner.

“What tends to happen is that the owner takes a look at all these energy improvements—new boilers, water heaters, roof insulation—and it allows them to lower costs. This provides them with an advantage for the renter looking for a value play, who can’t quite afford to be in the new tower downtown. Alternatively, the owner can put that saved money in their pocket because the rents are so high.”

Binette adds that unit and amenity improvements are the next facet to look at, as his clients want to be certain that the money going into a product will ensure continued occupancy should there be a future dip in the marketplace.

“While these rehabs can’t always compete with a new product and the expanded amenities spaces that are popular, improvements that target the meat of the rental market—where people are renting by choice as opposed to renting because they can’t afford a house—leads us to in-unit finishes of granite counters and stainless steel appliances, as well as carving out a new boutique set of amenities.”

Of course, no project is without its potential pitfalls, and Binette warns against overspending, underspending or spending in the wrong places. With the market as hot as it is today, overspending currently isn’t an issue. It could, however, manifest down the road if there is a hiccup in the economy (leading to unemployment) or if the homeownership rate spikes dramatically. Risks from underspending involve not capturing today’s renter and losing out on revenue. But spending in the wrong places is perhaps the most dangerous.

“We have seen a couple cases where developers have forgone those big decisions like central heating systems or a new roof by saying ‘we have another five years left to address it; we will deal with it then.’ Only later do they find out that either they don’t have the money or the repositioning program is not working well, and they start losing tenants and rents.”

But a good market and a smart plan can lead to fantastic results. The Regency, a 129-unit, 16-story tower repositioned by Trinity Financial in New Bedford, Mass., is a prime example. MassHousing foreclosed on the then-affordable asset in 2005. In 2009, Trinity Financial was selected to acquire and rehab the 15 percent occupied building, investing $30 million into the program. Binette worked with Trinity to design and execute the rehab, and by the end of 2011, the asset was fully leased up. Today, it is 98 percent full and commands the highest rents in the city.

“The original building had all types of issues associated with water penetration, and the units all needed an upgrade,” says Mathieu Zahler, project manager at Trinity Financial, who worked on the repositioning. “We gut-rehabilitated the entire asset, upgraded the kitchens and baths in all units, did a complete façade renovation, and installed new HVAC systems.”

The top floor had an underutilized commercial space that was converted to apartments, adding six new units. All work was done while the property was occupied, with residents moving into completed apartments while work was being done on their individual units. 33 of the apartments are now reserved as LIHTC units, making the property a market 75/25 affordable split.

“It is our general standard that whenever we take on a project, we do it to the best market-rate standards that we can,” Zhaler adds. “That is what we have done with The Regency. It now has a fitness room, media room and community room equipped with everything you would see in a new luxury product. Overall, it is a pretty compelling story as to the power of repositioning.”