Renovating in a Recession

5 min read

By Keat Foong, Executive EditorRead the side bar “Rehabbing Historic Properties: Where to Start?”Renovation strategies need to be readjusted in a recessionary environment. Apartment owners may not get a return on their rehab investment as market rents can stagnate or decline down the road. And prospects who are out of work, earning less, or insecure […]

By Keat Foong, Executive EditorRead the side bar “Rehabbing Historic Properties: Where to Start?”Renovation strategies need to be readjusted in a recessionary environment. Apartment owners may not get a return on their rehab investment as market rents can stagnate or decline down the road. And prospects who are out of work, earning less, or insecure about their jobs may not want to pay for the improvements. Further, financing is difficult to obtain, especially during the current credit crisis. In such an environment, many apartment owners have simply stopped renovating properties. “Overall, until the credit situation, as well as the economy, improves, we will see very few properties renovated,” predicts Rob Rosania, CEO of Stellar Management, which owns and manages 20,767 units in major cities including New York Chicago, San Francisco and Miami. Another apartment investor, Sterling American Properties Inc., has suspended renovations in some markets at this time, “because prospects are not paying for certain upgrades,” says Tom Dolan, senior vice president in charge of multifamily asset management. Sterling American Properties has invested in more than 25,000 units throughout the country. However, rent increases are still possible in many markets, such as in the West and Northeast. And provided apartment owners have the financial wherewithal or can obtain financing, they can still embark on property capital improvements, whether of existing properties or recently acquired ones. “In other markets, we are upgrading because we are in for the long haul,” says Dolan. Being selectiveOne of the most important steps to take is to make sure that the renovations will lead to a tangible return on investment. “It is critical that any upgrades that we make continue to provide a ‘spread’ in rents between un-renovated and renovated that justifies making this investment,” emphasizes Dave Woodward, CEO of The Laramar Group. “It is critical that these renovations pay for themselves in the form of higher rents.” The Laramar Group owns, acquires and manages apartments throughout the nation and has built up a $1 billion portfolio. For the company, every component of unit upgrades in a value-add project is analyzed to determine if it will justify an increase in rents, says Woodward. And the renovations have to be selective. In some cases, The Laramar Group has found that residents are no longer willing to pay higher rents for new kitchens and baths, but they may prefer in-unit washers and dryers. Hence, it may be more cost-effective to install washers and dryers rather than renovate the kitchens. In terms of return on investments, The Laramar Group underwrites renovations to produce annual returns of at least 20 percent (a five-year payback) on incremental dollars invested. Along the same line, Sterling American Properties, which acquires “solid-B” apartment properties, would generally enter into major renovations only if the renovations would yield a higher income. It requires double-digit returns north of 12 percent, says Dolan. “We will not enter into [the renovation] if the returns are single-digit,” he says. Rosania, of Stellar Management, points out that apartment owners need to ensure every dollar spent renovating the property is taken into account. “Not just dollars spent on only the apartments, or only the hallways, or only the lobby, but on everything,” he says. The total investment is then combined with the annual income to compute the return. Where do you start?Another decision-making component of a renovation project is what items to improve. Naturally, one of the first steps—especially in a high-rise—is to attend to any fundamental building system or building structural flaws, suggests Rosania. Examples of such items are the plumbing, the boilers, the air-conditioning system, the roofing, the façade and the windows—”everything that people take for granted.” “Provided the fundamental systems of the building are in good shape, the greatest return on investment dollars comes in improving the common areas—the lobbies, the business centers, the fitness centers—and the interior apartments,” says Rosania, whose company spared few expenses in the renovation, completed last October, of its 1,119-unit Enclave Silver Spring, Md. (pictured opposite and on this month’s cover).Rosania warns that one of the biggest mistakes is to renovate the interior units before the exteriors are done well. “Everyone has made this mistake,” he says. “If you renovate the apartments, but the lobby and common quarters are in terrible condition, it’d be irrelevant what you’ve done on the inside of the unit.” Strategies for the recessionWhat apartment feature is more important to the resident and what is less so may also change in a recession. Counter-intuitively, the clubhouse or business facility may not be the first items to forego renovating in a recession, Dolan says. For Sterling American Properties, three key amenity areas may be the first items to be renovated: the health club, the business center and the café area. Dolan points out that more residents will tend to use the community business center during a weak economy, as they try to avoid joining health clubs that charge membership fees. Similarly, business centers will tend to be most busy during recessions, as residents use them for preparing their resumés and finding jobs. “We rehab the amenities in the fitness centers and upgrade the equipment in the business centers, making sure the printers, scanners and computers are kept in great condition,” says Dolan. It is also important, he adds, to put in a java café in the clubhouse with gourmet coffee makers that are always available. The company may also concentrate on installing new appliances, such as stoves, refrigerators and dishwashers, in a recession. It is noteworthy, Dolan points out, that the kitchen may become more important as residents eat in more frequently. “Historically, people who rent tend to take out meals. In a down economy, however, they are cooking more at home.” How far the renovations should go depends on how much work the market will pay for in the current economic environment. The Laramar Group has scaled back the scope of renovation at some properties, so that the rent increase can be minimized, in order to appeal to price-sensitive residents, says Woodward. In markets that will pay for the upgrades, the company continues to conduct full renovations, he adds. And in some properties, some units will be renovated while others are left standard so that “we can offer two price points to our customers.” To comment e-mail [email protected]

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