If you’ve never heard the term “value-added” property before, it
refers to a real estate investment opportunity where the buyer will
recognize additional value from the purchase of the property, outside
of directly receiving monthly income from it. For example, when
many people buy real estate investments; they may be interested in
both the cap rate as well as the quality of the tenants in the building.
So they’ll be interested in the reliability of the monthly income
they’ll be receiving from their ownership of the property, also
to the long-term appreciation, they’ll be receiving from the property,
too.
But investors who seek value-added opportunities are interested in more than just a cap rate and in receiving regular monthly income. They want to find opportunities where they can add significantly to the equity value of the property, and to their own net worth, too. Keeping this in mind, let’s take a look at some examples of how investors can do this for themselves.
Let’s say there’s a single-tenant building where the rent is substantially below market. The owner signed a ten-year lease on the building eight years ago, and the lease still has two years to go. The owner needs cash right now, and they need to sell the building, but they’re going to need to sell it at a price a buyer would be willing to pay for it right now, considering that the lease is bringing in rent that is way below today’s fair market value. So the buyer and seller then negotiate a sale at a 4% cap rate to the buyer, even though buildings of this type typically sell for a higher cap rate, but the buyer recognizes that in just two years the building will then be worth 40% more when the lease expires, and they’ll either re-lease it, or they’ll sell it at that time.
In this above situation, by buying a value-added property, the investor is reaping far greater returns than they would have had they simply purchased a typical investment property at a normal cap rate.
As another example, a buyer may recognize that an industrial building with good, extended frontage on a high-traffic street could be purchased, converted into multi-tenant retail units, and then rented out at today’s current retail rental rates, adding substantially to the buyer’s net income as well as adding substantially to the value of the property itself.
Also, think for a moment about what has happened in recent decades with our shopping centers. We never used to see these kiosks with retail businesses in them right in the middle of the floors, containing businesses like cell phone companies trying to get you to switch over and begin doing business with them. But the first investors who began recognizing this opportunity began purchasing shopping centers and then adding and renting out these retail kiosks. Then they immediately began reaping an additional $1,000,000.00 or more in annual net income from these kiosks, before their competitors began recognizing this opportunity, and began buying more shopping centers themselves.
These are the kinds of investment opportunities that seasoned investors look for because they can end up making a ton of additional money from them.