Lifting Rocks: Let’s Talk about Identifying Hidden Value in a Multifamily Property…
“Things are not always what they seem; the first appearance deceives many; the intelligence of a few perceives what has been carefully hidden.” -Phaedrus
A regular reader reached out to us asking how we find the gems. “How are you able to find hidden value in a multifamily investment that many people fail to discover?”
That question brought a smile to our faces.
We were content because we knew we already covered some of these topics in previous blog posts. Even though the topics were not consolidated to address “hidden value” specifically, we believe pieces of those posts ultimately contribute to the whole “puzzle.”
Over the past months, we have written about some of the core elements of our investment process (e.g. Vacancy Rates, Rent Growth, Cap Rates, Tax Rates & CapEx). We have also written about our value-add strategy and execution (e.g. Business Plan, Asset Repositioning, & Marketing an Asset) post-due diligence.
When it comes down to discovering value, it is all about thinking outside-the-box. By taking a creative approach, we are able to identify many ways to increase cash flow -- ultimately from both a revenue and a cost perspective. (ask us about our new e-book, covering this topic)
Our discussion below covers some of the ways we uncover hidden value in a property.
Ripe Markets
“What markets reveal strong potential for a value-add property investment?”
Before we think about individual property characteristics, we consider a market’s potential. Part of CF Capital’s strategy is to maximize value creation. We would evaluate if a market has room for rent growth with limited competition. We also verify that a market has strong economic fundamentals and a solid demand for multifamily housing.
How do we do this?
As we discussed in previous blog posts, we start by gathering historical and current data to establish baselines. From there, we are able to analyze “what the market is telling us” through a cross-market comparison.
It is worth noting that part of CF Capital’s strategy is to maximize value creation. If we are able to capture the benefits from positive secular trends, we will increase our return on investment even further (beyond any executable items to improve revenue and/or costs).
Below Market Rate
KEY QUESTION: “Are current rents priced to today’s market value?”
One of the simplest ways to find hidden value is determining if a property’s current rental prices are set “appropriately.” We often run into cases where property managers fail to increase their rental prices to match what the rest of the market is willing to pay.
Among other more sophisticated exercises and models that we work on to find this hidden value, we place a lot of our attention to market comparables -- what are similar properties charging for their rental units. If the comparable properties are charging higher rents on average without their occupancy levels going down, this signals to us that we might have discovered hidden value.
Underutilized Space
KEY QUESTION: “Are there any underutilized spaces with the potential to convert to something that is revenue-generating?”
It is common to find a multifamily property inefficiently utilizing the space across the property, as well as in the buildings and individual units. In order to increase our top-line, some potential improvements we might consider are: creating additional bedrooms in empty (non-revenue-generating) space; creating value and subsequently charging fees for storage units; transforming empty buildings into a revenue-generating clubhouse; or adding other amenities across the property that are designed to create more demand to reside at our community.
Separate Garage Parking
KEY QUESTION: “Can detached garages be rented out separately for a fee?”
If there is a parking garage on the property, we sometimes discover that property managers offer this free-of-charge. Sometimes, we believe this type of “perk” makes sense. However, depending on the case, it might be a poor management decision to do so.
How can we tell?
If other comparable properties are charging a fee without any negative impact on their financial performance, the market is signalling to us that tenants are willing to pay for garage parking.
By looking deeper into a property, we are able to discover the potential benefits from adding a garage parking fee.
Marketing/Advertising
KEY QUESTION: “Are there opportunities to improve marketing or perceptual positioning of the property?”
In under-the-radar properties, we often find that property managers have plenty of room for improvement on the marketing front. However, poor marketing efforts would only be revealed after some investigative analysis and due diligence. In some circumstances, our intimate knowledge of the submarket and the demands of the consumers help us identify intangible aspects of the branding of an asset that would benefit the perceptual positioning of the asset in the minds of our target resident.
In these situations, the hidden value lies within the opportunity to improve presence, awareness, and efficiency of marketing.
With our trusted property management partners, we unlock this value by executing on a plan to rebrand the property, reposition the property, increase advertising in the proper channels, and/or streamline marketing operations. As we increase the awareness of the fresh brand in the submarket, we then solidify these repositions by ensuring our culture matches the essence of the brand. In other words, our properties truly “become” who we create them to be.
Utility Expenses
KEY QUESTION: “After due diligence, are there opportunities to improve utility charges?”
Occasionally, though not as common in current times, we come across a property manager that bears the costs of utilities. If we discover this during our investment process, we keep in mind the potential value that we create by reducing the costs of utilities. In such a case, we might bill utilities back to the tenant, in the event that doing so does not adversely impact tenant retention in excess of the effort. This could mean making changes to a few areas:
The tenant directly pays the bills for all of their utilities with the energy or water provider.
Any building or outdoor utility expense is factored into the tenant’s rental prices.
Anything outside of individual units that cause a utility expense, can be switched to an alternative to lower total utility costs (e.g. switching outdoor lights to solar-powered lights).
By capturing the value from cost reduction measures in the utilities area, we are able to increase our total cash flow.
Although this is not even close to an exhaustive list, we thought it would be helpful to provide some specific examples of how we discover hidden value to clue you in on a part of our creative process for identifying and capturing hidden value in the assets we invest in. You might consider using these ideas to springboard you towards capturing more value in your portfolio and can further rest assured that the team at CF Capital is tirelessly creating capital appreciation and cash flow generating activities to secure and maximize your investment should you decide to passively invest in our next opportunity.
As the multifamily bull market continues, opportunities to acquire existing properties have become more and more competitive while the increased demand for value-add properties is beginning to lower return potential in many markets. Finding the right value-add investing opportunity that generates value can be challenging, but can still offer the potential for healthy yield in certain markets. CF Capital’s goal is to find these markets and unlock any hidden value from our property investments enabling us to offer superior risk-adjusted returns to our partners and investors..
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