Proactive and Creative Value-Add

Asset Value-Add

An investment property, either owner-managed or managed by a professional management company can be either routinely managed to realize average returns or pro-actively managed to obtain superior returns.

Real estate investments generally fall into three categories – core, value-add, and opportunistic. Each category is attractive to and serves the risk-return appetite of certain type of investors.

Core investments are typically well-located properties with stabilized cashflow and require very little improvements from the new owner. They provide steady and predictable cash flow and are easily marketable. On the other hand, opportunistic investments often consist of vacant properties requiring substantial rehabilitation or raw land for development, both requiring long periods for income stabilization and involve a good mix of high risk and high return of and return on investment. Value-add investments typically fall between core and opportunistic investments.

Value-add is defined as follows: “an investment strategy that targets underperforming properties with upside potential. Physical value-add strategies aim to improve the property itself by completing deferred maintenance, renovating unit interiors or adding new amenities. Operational value-add strategies aim to improve property fundamentals by addressing managerial issues. The most successful value-add strategies often involve aspects of physical and operational value-add strategies. (Source: www.ArborCrowd.com).

Typically, investors engaged in value-add type investments have a property-specific strategy to add value to an underperforming asset that is operating at its below-par capacity for various reasons, including physical (e.g., needs roof or window replacement; converting utility metering to a per-unit basis) and operational (e.g., needs change of management; enforce paid parking) and requires structural or operational improvements and typically a mixture of both.

More challenging value-add investments may require revisioning (also called repurposing and repositioning) the property and may include refurbishing the interior (e.g., upgrading the units with new kitchens and bathrooms) and exterior (e.g., new or improved landscaping, resurfacing the parking lot), often major capital improvements that result in appreciation in value. Value-add revisioning include many of the one-time office buildings in New York City’s Lower Manhattan which are now successful luxury residential condominiums or rentals.

Proactive asset value creation goes beyond the routine preparation and execution of value-add plans. While typical value-add would involve investing in refurbishing and upgrading structural items (including reconfiguring of floor plans) and addressing operational or management issues, thus increasing the asset’s net operating income (NOI), creative value enhancement is about proactively identifying areas or aspects of the asset that could contribute additional streams of cash flow and bring out the hidden value.

In a broader sense, it is revitalizing the asset with the help of thinking outside-the-box, so to say, and revisioning alternative uses of the property, in addition to the typical as-of-right legal uses. It’s the additional shine on the dusty jewel!

Examples of Creative Value-Adds

Here are examples of cash flow streams identified in properties we appraised or observed in the recent past:

Telecom Antenna – Quite a few multifamily and commercial properties in the New York Metro area have leased roof-top space to telecom companies to install communication equipment and switching stations. Increased competition among telecom companies is forcing a few companies to find advantageous and yet reasonable hosting locations for their telecom transmission installations. These often long-term leases could be a stable source of cash flow to the property, although not every lender would like the income included in above the line cash flow while determining property value!

Billboard Advertising – Roof-based/Wall-Covered – Some of the owners have leased roof-top space for display ads. The installation of the ad structures come at no cost to the owners who enter into a long-term agreement with the ad companies for a monthly fee with no maintenance responsibility. However, most leases require long-term easements to the lessee which sometimes may interfere with any redevelopment plans for the property.

Roof-top Commercial Space – A few recent reinventions of old space and unmasking of hidden income are conversions of roof-top space into commercial area for recreational purposes, including sports or restaurant space.

Conversion to Retail – A few of the New York City properties in the past few years have legally converted street-level residential units to commercial units, thus creating commercial income from a doctor’s office or a day-care center.

Zoning and Highest & Best Use Analysis

Highest and best use is defined as “the use of an asset that maximizes its potential and that is possible, legally permissible, and financially feasible. The highest and best use may be for continuation of an asset’s existing use, or for some alternative use.” (The Dictionary of Real Estate Appraisal, 6th Edition, Appraisal Institute, Chicago).

The retail conversion and roof-top space conversion is within the purview of the zoning and permitted use groups. Hence the need for a thorough analysis not only of the as-is zoning rights, including any benefits accrued by rezoning of districts, but also of any potential variance that might be permitted at the subject property. For example, in an upstate New York town, a three-story carriage-house converted its historical carriage space to retail space. Quite a few garages in Brooklyn have been converted to retail/restaurant space, thanks to the demand for retail space due to changing consumer lifestyle in the local community.

Air Rights as Star-bucks - Often some of the hidden value is in the discovery of surplus buildable square footage (BSF) -- the difference of existing gross building area (GBA) and what is permissible under the as-of-right zoning floor area (ZFA) on the subject site which are considered transferable development rights (TDRs) or simply air rights. While one cannot lease surplus air rights, one can out-right sell them at a discount and pay off a portion of the debt!

Market-Supported Rationale

As in the case of making investment decisions in acquiring and renovating a “value-add” property, a professional analysis is imperative in identifying and evaluating creative value-add opportunities. They need to be well supported professional market assessment, with local demographics, changing consumer preferences and demand for and supply of services that are considered at the property location, such as creation of a roof-top recreation/restaurant space or retail stores/community space in the place of street-level residential units. A cost-benefit analysis of the specific project is a must to ensure long-term contribution of the commercial space or amenity to the bottom line. The key questions to ask are: Has the locality changed or is changing? What type of space or amenity is most needed? Are the users willing to pay for it and how much? Is the new use or space creation commercially viable in terms of cost and net benefit to the operational profits?

Conclusion

Every asset earns standard returns in good times. It is the hard times that an investor or the property management should be prepared for with creative strategies that increase a property’s net operating income and naturally enhance its long-term value that would exceed its exit price. A proactive approach to property analysis to unlock hidden opportunities is the key to go beyond the routine value-add asset acquisition, ownership and management.