How To Recognize The 5 Basic Phases Relating To A Well Thought Out Value-Add Multifamily Real Estate
Life, love, the moon, notetaking? What do all of these things have in common with value-add multifamily syndications? They are all moving through phases, a series of steps that go from start to finish. Yes, even notetaking! 😮 Depending on whom you are listening to or even your culture, the number of phases for each will vary. For instance, most of us have heard of a new moon, a crescent moon, or a full moon. Did you know that the Hawaiian culture has 30 phases of the moon, one for each day?
The Five Phases of a Value-Add Multifamily Syndication
Similarly, each real estate syndication goes through a progression of stages with a clear beginning, middle, and end, ensuring individual investors operate as one, according to a clear business plan.
Phase #1 – Acquire
The first stage begins with sponsors getting a property under contract. Not only can finding a great property be difficult, but this phase also requires impeccable underwriting skills and reliable projection calculations.
Once under contract, sponsors work diligently to discover the property's needs, record estimated expenses, and update the business plan accordingly. After the sponsors and we are confident with the research, the deal, and the projections, we share the opportunity with investors like you to gauge interest. Once all investors send in their funds, we then close on the property.
Phase #2 – Add Value
The term "value-add" means precisely what it sounds like; we're adding value to the property, which is why renovations typically kick off upon closing.
All per the business plan, transitions begin with the property management team and renovations on vacant units. This phase can last 12 to 18 months or longer, depending on the time it takes for all tenants' leases to expire and for all old units to be renovated.
Exterior and common area renovations may also be made, such as updating or adding light fixtures, a dog park, covered parking, or landscaping.
Phase #3 – Refinance
Since commercial properties are valued according to the income they generate, the renovation phase's whole point is to fetch rent premiums to increase revenue.
Most tenants will happily pay an additional $100 per month for the opportunity to move into an updated unit. If the apartment complex has 100 units, that's an additional $120,000 per year in rental income, which, at a conservative 10% cap rate, equates to $1,200,000 in additional equity.
With that additional equity, a sponsor may attempt to refinance or sell the property early if the market is right. Although thrilling, neither of these is guaranteed. You would receive a portion of your initial investment back through a refinance or supplemental loan while still cash flowing as if you continued to invest the entire amount.
Let's pretend you invested $100,000 into a value-add multifamily syndication, and after 18 months, the sponsors refinanced the property and returned 40 percent of your original capital. Here's where you celebrate because this means you got back $40,000, plus continuous cash flow distributions of 8-10% off your total $100,000 original investment.
Phase #4 – Hold
The next phase constitutes holding the asset while collecting cash-on-cash returns (aka, cash flow). Since the value-add phases are complete and the riskiest phases have passed, the focus shifts toward attracting great tenants and generating healthy revenue.
Throughout the hold period, rent increases at a nominally low percentage each year, increasing revenue and contributing toward a steady appreciation of the property. This phase's length, preferably 5 years or less, is based on the individual property, sponsor, and business plan.
Phase #5 – Sell
At this point, the property exhibits completed updates, increased revenues, and appreciation. So, the best use of investor capital is to sell the property so that they can seek their next investment project. During the disposition phase, sponsors prepare the asset for sale.
Sometimes the asset can be sold off-market, creating minimal disruption for tenants. Otherwise, sponsors muster through the whole listing and sale process. Occasionally, if investors agree, the sponsor may initiate a 1031 exchange. This allows investors to roll their capital and proceeds into another deal with the same sponsor.
Either way, once the sale is complete, you get your original capital back, plus a percentage of the profits. Time to pop those corks! 💥
There you have it!
Like other things, including life itself, you have structure and focus within each step. Remember, every deal is different, and not all syndications go through all five phases.
As a passive investor, you get to avoid the legwork. However, you still want to thoroughly understand the typical phases of the value-add multifamily syndication process, so you're informed every step of the way.