So should you update or upgrade your apartment building to get ready for sale? This is a can be a tricky decision to make because there are several factors involved. If you just want your building to look pretty again then its just a personal decision. BUT If you want to increase the value here are some questions to ask yourself....
1. First and foremost what kind of upgrades are we talking about? Curb appeal, mechanical systems, or actual unit upgrades?...Mechanical system upgrades are not noticeable and usually only increase value when the upgrades are more efficient and will decrease your expense cost. They are usually your highest cap ex so I recommend only upgrade these as necessary. So focusing on curb appeal and actual unit upgrades...
2.Does your building have low occupancy?.... If so then this might be an easy decision, if you know by upgrading your building you can drive up your occupancy then definitely it's your only choice.
3.If occupancy is not a problem can your upgrades increase your rents?... So every tenant wants new appliances, new cabinets, new flooring, etc but if your rents are already at market levels then this would not be beneficial to you. You need to increase NOI to justify upgrades so if not your rents it needs to come from somewhere.
4. Can your upgrades change your selling cap rate?... So can your upgrades change the grade of your property from maybe a "D" to "C" or "C" to "B" then this could affect your selling cap rate not always. There are many factors within your market that will help with this decision.
A little story about a specific property that spurred me to post this.... We were negotiating on a 35 unit building they were asking about 1mm. He had purchased the property 3 years earlier for 750k. They then proceeded to sink 250k into upgrades.
After evaluating the financial analysis we came to the conclusion that this property was still worth closer to the original purchase of 750k. Because we are local to the property I knew that is has always maintained a very high occupancy but just totally outdated and not very physically attractive. We knew it was its location that kept it 94% rented and rents close to market rates.
The Broker said that he would not budge on price because he has spent 250k upgrading it to make it nice. He just could not realize that it would not be worth at least that much more. He had been used to flipping houses the broker told me and thought this would work much the same way.
In the end his upgrades did not increase the value so please take time to evaluate the upgrade plan to your apartment buildings because we know its not the same as upgrading a house.
Please share any other factors to look for so we can all learn. Thanks
The only thing that increases value on multi-family properties is increased income. The value of the property is completely based off of that. So, I understand exactly what you're saying.
@James Stevens so succinct, so true. (as long as you mean NET operating income) and not just income. :)
Yes @Joe Fairless that is what I meant. Good point (that I left out).
I disagree to a slight extent. Lets look at two properties A & B. On paper they are exactly the same. They are both 10 unit properties with average rents in the $500 range and they have the same NOI after all analyses.
However, property A needs a new roof and a new HVAC system. One can argue that these types of upgrades will have no effect on the rent that the property could receive. But a seasoned buyer will recognize this and immediately discount the property from the CAP rate valuation knowing that their future CAP EX will be greater.
Property B is right in line with the rest of the neighborhood and is a true reflection of the market. The CAP rate reflects what its true value is.
By making upgrades to property A, the highest you can increase its value to is equivalent to property B. Technically we raised the value of property A, but only to be in line with what everyone else in the market is currently paying.
@Clint Williams to piggy back on your story. Even a flipper should know that every dollar you put into a flip doesn't always come back if you've reached the top of the market. Just like in a mult-family, if you don't make upgrades that either increase the income or decrease the expenses, you haven't really changed the value unless the property started far below the standard of the market.
@Jeff Arndt I agree with your example and understand exactly what you mean by it.
Upgrades and maintenance items are two totally DIFFERENT things. Replacing a roof isn't an upgrade but a maintenance issue.
Just like a house people are not going to pay more just because a new carpet is in. It's nice and will help it sell faster but they will generally not pay the extra value of cost it took to replace it.
A property needing a roof right away is deferred capex rather than ongoing. You simply deduct off the purchase price you would pay or make the seller fix or replace to your standards prior to closing.
People overpay for things all the time. If the seller for example with the apartment building is making good cash flow then it doesn't makes sense to eat 250,000. They could owner finance someone at a higher market cost with money down.
A transaction happens when a buyer and sellers goals can mutually align upfront or through intensive negotiations. Sometimes it just doesn't work or it's not the right time to engage.
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