Value-add strategies in real estate
Tomasz Wozniak 
August 2, 2023
Tomasz Wozniak
August 2, 2023 Value-add strategy in real estate involves purchasing an existing asset that is not operating to its full potential and subsequently increasing the long term value of the asset.
There might be various reasons for an asset not performing to its full potential – the asset might be outdated and require CAPEX for refurbishment, it may have a tenant that is paying below market rent, it may have a poor management team operating the asset, or it may have an unusually low occupancy rate.
The key to the successful execution of a value add strategy is identifying an asset with hidden potential value that can be unlocked, resulting in an improved return on the investment.
Some of the value-add strategies in real estate include:
Refurbishment – This strategy focuses on the physical aspect of the asset and involves purchasing an outdated property that requires renovations.
Adaptive reuse – Particularly common nowadays, adaptive reuse involves converting one type of real estate into something different – for example, converting an old office building into a block of residential flats or converting an unused warehouse into retail property.
Improvement of tenancy – Improving the tenancy of the property can be done via either increasing the tenancy rate of the property or replacing tenants paying below market rents with ones that would pay the full market price.
Despite the fact that value-add strategies focus on underperforming assets, financing can still be utilized as a part of the deal. Availability of funding sources and products is not as wide as top grade properties and it requires specialists with particular connections and expertise– that’s where we come in to support our clients.
Financing products for value add strategies involve debt instruments, mezzanine finance as well as JV-equity structures, depending on the deal and requirements of the sponsor. However, it is unlikely that the funding would be provided by a mainstream bank – that is because these institutions typically focus on top grade properties without any inefficiencies. Funding sources for value add strategies would therefore include non-bank lenders, development finance providers, real estate investment firms and even family offices – these companies will typically have a higher risk tolerance and are able to take a long term view on the asset.
Potential higher return on investment typically comes with increased risk hence why execution of these transactions, as well as having the right team in place, is absolutely crucial. Some of the key risks are:
Risk of timing –it is not possible to increase the value of properties overnight. This process can take between a few weeks to even a year and, in most cases, delays in execution lead to delays in improved cash flow – this is not the case if an investor purchases a well-established property with an excellent tenant as these assets produce income on day one. It’s important for investors to budget appropriately and be conservative when planning the timescale of the deal.
Risk of increasing refurbishment costs – as we have seen recently, costs of refurbishing property can increase rapidly and is, in some cases, out of control of the investor. It’s prudent to assume contingency between 5% – 10% of cost to avoid unplanned cost overrun.
If you, or one of your clients, is considering a value-add strategy in real estate, please get in touch. We will be happy to share our insights and assist in raising the most suitable type of financing.