Low Vacancies Create Additional Value Add Opportunities for Class-B Assets
June 17, 2016
We all know the infamous multifamily Class-B value add strategy: buy below market value, perform improvements and then raise rents to meet the market. But what happens when your rents reach market? How can you push the asset to perform even better?
In an up-market like the current one, in which vacancies are low and demand is high, you, as a landlord, have the pricing power. This means you can collect premiums above market rent for upgraded units. For example, some renters are willing to pay more for apartments with new countertops and nicer fixtures. In addition, installing these upgrades are often less disruptive and cheaper than the major redevelopment that a Class-B asset might initially require.
When seeking rent premiums, keep these tips in mind:
Choose upgrades wisely.
Which improvements will generate the biggest bang for your buck is somewhat dependent on sub-market. Here are some of the amenities that are most demanded by today’s renters:
Stainless Steel Appliances
Brushed Steel Finishes
In-unit Washers & Dryers
Open Floor Plans – some units offer the opportunity to open up the kitchen area to the rest of the unit, perhaps including a kitchen island to create separation from dining and living room areas
For best results, think about your ideal tenant and cater to his or her lifestyle expectations.
Don’t be cheap.
Some landlords looking for easy premiums resort to “cheap luxury.” A unit gets a fancy facelift, but lacks quality or durability. Inexpensive composite materials may look the part, but more discerning tenants can spot these in a heartbeat. Furthermore, these cheaper upgrades will wear out more quickly and come back to bite you when they require repairs or replacement.
What’s popular or unique today may be a turn-off tomorrow (shag carpet, anyone?). Your strategy might be to generate premiums by making some units very unique and stylish, but if you want to maintain continuity with your other units, choose improvements that will be durable and classic.
What is classic? According to Jeff Kayce, Vice President of Bozzuto Development, “Whatever interesting finish we do for one project, is not cool enough for the next. But rich, clean and unfussy finishes consistently do well.” Consider neutral paint colors like beige and gray for walls and white for trim, granite or marble countertops and hardwood cabinets and molding.
Don’t disrupt a good thing.
Keep in mind, if an asset is performing well in its respective market, there’s no need to push it too far. Don’t be excessive. Make sure renters can actually afford your premiums. Before installing major upgrades, test one unit at a time with different combinations of amenities to determine what tenants want and how much they are willing to pay.
Gain from the gap.
To avoid encroaching on Class-A rents, know the rent gap between classes in your market. Value-add projects are most successful when there’s a wide difference between the average rents of a new class-A apartment compared to a Class-B or Class-C unit.
You can’t turn a Class-B into a Class-A.
Finally, no matter what you do, a Class-B apartment will never be as desirable as a new Class-A unit in the same market. Therefore, if you require Class-A rents to support the expensive improvements you’ve made, you’ve gone too far. Be careful to weigh the cost of upgrades with the resulting premiums.
You’re probably thinking, “Wait, what about Class-C properties?” Well, for the most part, all of the above principles apply. However, due to the unchangeable aspects of some Class-C properties (functional obsolescence such as outdated architecture, baseboard hot water heating, 1-bathroom floor plans, etc.), a Class-C property tends to have more holding it back than a newer Class-B. Therefore, upgrades may not produce as much return, but will still be effective in generating premiums in a low-vacancy market.