The “top-down” component of the strategy is focusing on the suitable market to carry out value-add investing, but the “bottom-up” component is as important. On an asset-by-asset basis doing property-level screening and discerning acquisition opportunities. Firms can screen prospects by seeking for inexpensive, underperforming assets in desirable places. Each value-add investor should consider the property’s size, age, layout, amenities, and location, depending on their preferences and real estate knowledge.

Choosing the ideal value-added acquisition opportunity isn’t exactly plucking low-hanging fruit. While many properties may be eligible for this technique just based on their worth or condition, some may be too costly to repair or functionally obsolete. What appears to be a “deep-value” opportunity could easily be a “value trap.”

As a result, the choice here is between prospective revenue and renovation risk. Well-maintained and stable, typical Class-A buildings in city centers often have minimal room for rent increase. These newly built assets are also more vulnerable to new construction, since they compete directly with new supply entering the market, making it difficult to maintain occupancy and rent increases, especially in a growing, over-supplied market. Class-Cs, on the other hand, charge below-market rents, but with fewer tenant turnover, the capacity of investors to raise rents is constrained by potential tenants’ willingness to pay. Given that the key discount factors on these Class-C multifamily buildings are invariable property qualities like layout and location, apartment improvements alone will not be sufficient to attract a new group of tenants ready to pay a high enough rent to cover the renovation costs.

With Class-B assets, value-add investors can find a happy medium between cost and prospective value. Capitalization rates for Class-B value-add investment properties are higher than those for core, Class-A assets. In opposed to Class-A assets, Class-B assets have greater natural room to raise rents and lower operating expenses, making them less reliant on cap rate reduction. Class-B multifamily investors can offer tenants high-quality housing options without paying Class-A rent by renovating each unit, common area, and property exteriors, justifying rent increases and attracting potential tenant demand from those looking for high-quality housing without breaking the bank.

Following preliminary screening and identification of acquisition targets, the sponsor must do rigorous due diligence and get a full grasp of a property’s physical condition. Undiscovered structural defects and other hidden difficulties can deviate from the original underwriting and put the project’s budget in jeopardy. To lessen investor exposure to cost overruns and delayed stabilization, the sponsor must anticipate any surprises and account for potential refurbishment issues ahead to acquisition in the underwriting. This is the stage of value-add investing when selecting a manager is most vital.

Passive investors should choose assets carefully depending on the sponsor’s real estate experience. Investors must consider whether the sponsor is competent of conducting complete due diligence, completely assessing the property condition, and making the appropriate asset selection judgment call.

In the middle market, where assets are often inefficiently priced, passive investors must rely on institutional sponsors who can identify the right acquisition opportunity and execute it properly using their deep experience, negotiating power, information advantage, development expertise, and brokerage connections. We at MarketSpace Capital like to work with seasoned sponsors. We conduct in-house sponsor-level and transaction-level due diligence to enable investors wishing to profit from value-add investing opportunities with an additional degree of security.