Why Stabilized Plays Are Gaining Market Share

Lenders will typically offer full leverage on stabilized assets because rents are relatively high compared to the expenses, notes Stepp Commercial's Mark Ventre.
Mark Ventre   Photo by Bradford Rogne Photography

Ask any multifamily buyer what they look for in a deal and chances are the first thing they’ll say is they want something that “makes sense.”  It turns out what that really means is they are looking for a building to which they can add value. 

The majority of all inquiries I receive are from value-add opportunistic buyers that are hoping to find an underperforming asset, preferably owned by an unsophisticated mom and pop for a generation or more.  Maybe someone in the family passed away and the kids want to sell and split the proceeds, or the owner is fed up with managing pesky tenants and wants to exchange into a triple-net leased asset. 

These apartment deals make for a compelling story; the basis is relatively low, and buyers can roll up their sleeves and get their hands dirty by relocating tenants and renovating units.  Over time, or often very quickly, they are able to reposition the asset with the intention of refinancing or selling.

So, if most of the buyers are value-add, who’s buying the stabilized deals that have already been renovated? 

The answer may be surprising.  

If I had been asked this question just a few years ago, I would have said a high net worth individual or family, like a doctor or an accountant who has a job in a different industry and is looking for a turnkey asset for which they won’t have to lift a finger.  They have neither the time nor the inclination to rehab a tired building with a significant deferred maintenance. That is not the usual case anymore, however. The stabilized buyer profile is changing, and the pool is increasing. Many sophisticated buyers—from small family offices to large institutions—are seeing these deals as opportunities to capitalize on immediate cash flow and to offset those portfolios with considerable value-add exposure.

Rent Laws Changing the Outlook

With the ever-changing laws that progressively favor the tenant, it is becoming increasingly difficult and costly to reposition assets in a timely manner as to execute traditional value-add business models.

Why buy a 3.5 percent cap deal with the hopes of renovating to a 6 percent cap, when you can buy a stabilized 5 percent cap and grow to a 6 percent cap organically by yearly rent increases in the same amount of time it would take to get there by repositioning?

Investors are realizing there are several key advantages to these stabilized deals: more cash flow, no deferred maintenance, no low-paying legacy tenants, and there’s a healthy turnover so the building will remain at or close to market, which is especially important for markets concerned with vacancy control. 

Lenders will typically offer full leverage on stabilized assets because rents are relatively high compared to the expenses. Placing long-term interest-only debt with today’s rates under 4 percent will yield aggressive returns that rival many other safe investments, and it will help subsidize the value-add components to portfolios that aren’t yet generating cash flow.

As more of these repositioned deals come online, the cap rates will likely become more competitive.  So while there will always be a market for the value-add opportunities, the stabilized play is steadily gaining market share. 

Expect to see increased interest—and opportunities—in this product as we move into the latter stages of the real estate cycle.

Mark Ventre is Senior Vice President of Stepp Commercial.