Sift Through White Noise to Uncover Hidden Value
- May 24, 2017
Liquidity is plentiful, and there is a ton of capital chasing multifamily assets. It is not uncommon for sellers to receive 10 or more offers on well-priced apartment deals. As a result, having systems in place to quickly uncover value-add opportunities is critical. There are two primary areas my team considers in small to midsize apartment deals: the market dynamics and operational aspects of the property.
Interest Rate Sensitivity Analysis
An interest-rate-sensitivity analysis is key to understanding levered returns and the impact rising interest rates may have on yield. Depending on the debt structure, it can take anywhere from two to six months to finance a commercial acquisition. In this current environment, we must anticipate that interest rates may increase while the property is under contract. In fact, at one point after the presidential election, interest rates moved by 70 basis points in a five-week period. In a recent interest-rate-sensitivity analysis, my team discovered that for every 25 basis points, interest rate moves affected the cash-on-cash return by about $12,000. In this scenario, the 25-basis-point move-in rates had a $150,000 delta on the offer price.
Internal Rate of Return (IRR)
In addition, we want to consider the hold period and account for inflation affecting non-controllable expenses year over year. Non-controllable expenses include property taxes, insurance, utilities and scavenger service.
A comprehensive rent study will uncover what other submarket owners charge for rent, and this will help determine what the rents are relative to the marketplace. We also look to historical rents to determine year over year rent growth trends in your submarket. These considerations are vitally important in determining your internal rate of return (IRR). Rents typically range in any given submarket between low, medium and high. If the targeted acquisition is in the middle/average rent range, we want to look for opportunities to make improvements to attract a higher quality renter pool and level up. It is also important to look at the rent history and trends of the submarket. If we know what rent the market was getting for similar rentals five and 10 years ago, then we can use this to more actively predict where rents may trend during the hold period.
Operational aspects of a property or portfolio often present opportunities to scale and develop efficiencies. Whether its controllable expenses that include third-party management and other costs associated with the day to day operations of that particular asset or non-controllable expenses, such as utilities, we sift through the expenses to identify areas to improve overall performance of the asset.
Rebranding and repositioning of an asset such as new signage, landscaping and a name change are ways in which owners can target and elevate a renter pool. Additional amenities may not see a dollar-for-dollar profit margin; however, if your residents are comfortable they will stay longer, and there is savings because of less turnover of apartments. Some amenities packages include updating or carving out an area for fitness center. Some clients are adding outdoor kitchens, grills, fire pits and picnic areas. Unit upgrades include dishwashers, upgrading cabinets, countertops and flooring. Determining if there is an opportunity to add cable and WI-FI, charging stations and work spaces where residents can hang out work on their laptops is very important, especially for the Millennial renter pool.
We often compare the property to similarly sized or classed assets to determine whether the property is over- or under-staffed and are the employee’s over- or under-paid. If the property is understaffed there will be unnecessary delay in fulfilling work orders and residents won’t be happy. If the property is overstaffed, then operations budget creates unnecessary drag on NOI.
Utility expenses are generally non-controllable, but we encourage owners to constantly seek efficiencies. A client recently acquired an all-electric building built in the 1970s, and during our deal analysis, my team uncovered an opportunity to add value by adding solar panels to the building. Shortly after the closing the buyer added the solar panels and is pleased with the results.
If the building is running on a boiler, how efficient is the boiler? We look for various ways to seal the envelope. If heat is escaping because the pipes aren’t insulated or is the roof cavity insulated, determine if the windows need replacing. A simple, inexpensive way to increase the performance of a boiler is to check and change and calibrate the valves on radiators. These tweaks would reduce utility cost and increase boiler efficiency.
Having a strong team to sift through the white noise and uncover hidden value, is crucial in this competitive market.
Anthony Hardy is a senior associate at Marcus & Millichap with 20 years of experience helping clients create and preserve wealth through the timely acquisition and disposition of multifamily properties.
Sales data includes transactions valued at $1 million and greater unless otherwise noted.