Some real estate transactions involve a “value add” strategy, wherein the interior units will receive cosmetic upgrades and the exterior of the property could even be upgraded.

Modeling interior renovations correctly is no easy task.

Most commonly done, tenant leases expire, the tenant moves out, and the unit is then renovated while it is vacant.

It’s clear that the unit being renovated will not be generating income while offline.

This is an important factor to consider when underwriting your deal.

So while these units are offline, the property will experience higher physical vacancy (in this case renovation vacancy).

Keep in mind the unit will also be offline while the unit is marketed online. It may take time to advertise the unit, conduct tours, and possibly another 30 days before the tenant moves in.

Important: That being said, it would not be uncommon for the property to experience a dip in net operating income while going through a substantial interior value-add business plan as shown below.

As you can see, the trend in the net operating income graph resembles the yellow trend line in the first picture.

Do this when you underwrite your next value-add deal:

1. Have an accurate renovation timing schedule in your underwriting model that takes into account down units.

2. Use higher physical vacancy assumptions during your planned renovation months.

3. Consider how many units will be taken offline each month. Determine how quickly they can be preleased or filled once renovation is complete.

• The Federal Reserve raised the federal funds rate by 0.25%

• Multifamily Syndicators Come Under Scrutiny

• Cap Rates for Prime Multifamily Assets Stabilize in Q2

• 3 rental classes compete for dollars and tenants

• Fed staff drop US recession forecast, Powell says

• U.S. Cap Rate Survey H1 2023

• Apartment List National Rent Report

• Zumper National Rent Report

📈 Chart of The Week

Apartment Demand Finally Matching Up with Job and Income Growth

New lease traffic has been strong, indicating renters are shopping around as record volumes of supply have expanded their options. Thus, rent growth is faltering as supply does what it’s supposed to do – slow down intense price increases.

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