Vintage Value: Preserving Affordability Through Property Rehab

Ryan Perk

Prior to the pandemic, multifamily development was on a hot streak—a trend that has continued in markets across the U.S. But the majority of new and refurbished product is Class A, geared toward high-end renters. What are the options, then, for families on the hunt for quality housing that fits a more modest budget?

The need for housing at affordable rates is an issue that pre-dates COVID-19. According to The Joint Center for Housing Studies’ (JCHS) latest State of the Nation’s Housing Report, over 20 million renters (46%) put more than 30 percent of their incomes toward housing in 2019. This was only exacerbated during the pandemic, with more than half of all renter households losing income between March 2020 and March 2021.

That same JCHS study found that the median age of the U.S. housing inventory rose from 34 to 41 years between 2007 and 2019. These two factors—dwindling access to workforce housing and an aging housing stock—are really two sides of the same coin, as one of the best ways to address the dearth of these housing options is by rehabilitating existing vintage properties.

While vintage, unoccupied buildings may require a lot of due diligence and rehabilitation work, the benefits of creating more “naturally occurring affordable housing”—which is simply unsubsidized housing that low- and moderate-income families in a particular neighborhood can actually afford—outweigh the perceived risks when done correctly. Not only will a developer see returns on the investment, but generations of residents deeply connected to their community will have an attractive and affordable place to live. But before getting started, there are a few considerations to evaluate on both the acquisition and rehabilitation fronts.

Acquisition

Typically, the best deals are those that will require the most effort and properties that haven’t been occupied for decades and that will require full gut rehabs can return incredible value. Heavily distressed assets can be acquired for a discount and, following extensive capital improvements, returned to full occupancy. Buyers are also in a position to get a few basis points on these deals relative to something turnkey.

Because these assets won’t generate positive cash-flow for a long time, they have a smaller buyer pool and higher short-term carrying costs. Those with longer investment horizons will find that value-add projects can perform better in the long run, so a buyer has to be prepared to hold and maintain the asset.

Off-market deals, bankruptcies, foreclosures, REO and short sales can be more difficult than a standard market transaction, though they typically offer the brightest upside because cost to entry can be lower. Years ago, these deals were quite easy to come by, but competition has increased, and they are now more difficult to find. There was a time when acquiring multifamily properties through cash sales could be a major competitive advantage. But competition has greatly increased as more players enter the market, especially over the last few years and from sources all over the globe. One key factor to consider is the building’s age.

While more issues are likely to crop up in older buildings, these assets also tend to have better bones in place. If the acquisition team is able to work closely with the construction managers, they can craft a more refined properly budget that will highlight the building’s needs for long-term ownership.

Buyers are rightfully taking advantage of low rates and offer terms have also changed in recent years—so even if an investor isn’t necessarily a cash buyer, they still have a fast-closing window and/or hard earnest money along the way. In addition, foreign investors new to the market are pushing existing owners out of the Class A space, compelling them to seek out downstream opportunities. These and other factors are pushing pricing higher and higher. As a result, the supply of vintage apartment buildings has decreased or remained flat over the years—even as demand has exploded.

Rehabilitation

Of course, acquiring a neglected asset is only part of the solution. Just as important is dedicating what can often be considerable resources—both time and money—to bring that property up to habitable standards.

One of the most overlooked factors when buying older properties are the code enforcement hurdles that lie ahead. While a smaller owner with one or two assets may cross their fingers and hope that their work is able to fly under the radar, that strategy simply does not work at scale. Delays in the inspection process will lead to delays in construction progress and lost revenue.

What can help? For starters, working with construction managers who keep current with building codes and maintain strong working relationships with the buildings departments of the municipalities in which they operate. Pulling the wrong permit will extend a project’s timetable while failing an inspection that requires reconstruction of already completed work will quickly eat up the construction budget.

Of course, it’s not enough to simply do the minimum required for an occupancy permit. Even among naturally occurring affordable housing residents, the market demands a higher level of finish. And opting for certain finishes rather than their cheaper alternatives can be beneficial to the owner as well as the renter.

Choosing to install stainless steel appliances may have a higher upfront cost, but it also heightens demand for that unit. But it’s not just aesthetics; it’s also durability. By opting for hardier finishes—easy-to-maintain and replace vinyl plank flooring instead of cheap carpet or high heat- and chip-resistant, long-lasting granite countertops instead of laminate, for example—an owner can get more mileage out of their rehabilitation efforts while simultaneously attracting more residents.

Reassessing the materials used during rehabilitation work, both in terms of what the competition is doing and how past decisions have performed, should be a regular task. Finish quality has greatly improved over the last five years; installing to what may have been a B-grade standard a decade ago could now make a unit poorly positioned in the market.

However, best practices and best finishes are two very different things, making it all too easy to pick a nice finish and overspend. As with any deal, it’s important to optimize value and stay correctly positioned relative to competition and what the local market will support.

The nation’s stock of vintage properties plays a pivotal role for both real estate investors and the wider community. By focusing on acquiring and rehabbing derelict assets in underserved neighborhoods where quality housing is hard to come by, property owners can create long-term value while simultaneously increasing access to safe and affordable workforce housing for generations to come.

Ryan Perk has been with Pangea Properties since 2014 and currently serves as senior acquisitions associate. He attended Indiana University where he received a double major from the Kelley School of Business. Ryan loves all things real estate, the broader financial market, and good bourbon. His favorite activities include exploring all of the great neighborhoods of Chicago and discovering all of the fantastic food options out there.