Updated: Mar 7
The COVID-19 pandemic has created a catastrophe around the world, including the United States. In addition to the staggering loss of life, the economy has taken a major blow that hasn’t been seen since the recession during World War II. And just as the economy began to recover, a major spike in new cases occurred that has sent many states reeling, and reversing their attempt at restarting the economy
The resulting unemployment and unprecedented job losses have many multifamily property owners concerned, and rightly so. After all, it’s hard for people without income to pay monthly rent, which could have a devastating impact on the property’s cash flow. So far, Blue Lake Capital, my company, has been fortunate because we’ve been able to weather the storm. In fact, we’ve been able to generate a rent increase of almost 30% during this time. In this article I will share with you how we did it, step by step.
Implementing a Value-Add Strategy
Implementing a value-add strategy requires either increasing rents or reducing expenses. With value-add, rent increases are based on renovating units and charging tenants a higher rent. The scope of renovation can change depending on trends, but a popular strategy is to change out older appliances with black or conventional stainless-steel ones, install plank flooring, painting the units, and adding new kitchen and bathroom cabinet doors. It also includes installing a new backsplash, new hardware, and new lighting. Generally, the costs can run from $2K to $7K.
After the renovation, we can usually increase rents by 15% to 20%. The difference between the existing rent and the new rent that incorporates the increase is called the “premium.” As an example, if we were charging $1,000 per month pre-renovation, and we achieved a 20% premium, the new rent would be $1,200. That’s an increase of $2,400 per year per unit in income that goes directly to the bottom line.
It’s all based on the market, taking into consideration what people are paying in the market, and availability of units. You can also increase the value of the property with upgraded landscaping, painting, and other exterior renovations, but the main driver of a rent increase is renovating the units. In addition, when we renovate units we’re not only increasing our income, we’re also increasing the value of the property, and when we go to sell we can usually sell it at a much higher price.
When purchasing a multifamily property, we start the value-add process by renovating all vacant units first, and each time a tenant leaves (when their lease ends), we renovate the unit and rent it with the higher rent. That was the process used pre-COVID-19. After COVID-19 hit, things changed.
Post-COVID-19 Value-Add Strategy
Prior to COVID-19, we implemented our value-add strategy and started renovating all the vacant units almost immediately, and then put the units back on the market. When COVID-19 hit, most sponsors put renovations on hold. There were three reasons for doing that.
First, considering that we we’re worried about rent collections from existing tenants, it didn’t make sense to pursue increased rents. We wanted to focus on collecting rents from existing tenants, and also make sure that tenants stay, instead of encouraging them to leave so we can renovate their units and put them back on the market at a higher price. Whenever a lease was ending, we told tenants we were going to renew their leases for a zero percent increase.
The second reason was that we assumed it would be much easier to find a tenant who was willing to pay $1,000 per month, for example, than one who was willing to pay $1,200 per month.