Outsized Real Estate Investment Returns Through Value-Add Investing

It’s no mystery that real estate has long been regarded as the investment of choice for many millionaires. There are countless reasons for this – tax advantages, monthly cash flow, financial leverage, long term stability, asset appreciation – but one that’s often overlooked is the disproportionate returns that can be realized through a bit of creativity and business acumen.

The potential value-add opportunities that real estate affords are practically endless and should be a primary consideration when developing your wealth management plan. In this article, we’ll discuss a few ways that an experienced real estate company can optimize a property to create an income-generating machine, providing you with returns which would be difficult to find in any other investment category.

Speculation and Modern Finance

When considering all the benefits that real estate has to offer, it’s important to consider the alternatives. What is the opportunity cost you’re missing out on by choosing to move money into real estate? Are you better off investing in the stock market or other popular asset classes, many of which can be purchased with the click of a button?

Let’s first consider the stock market. The average return of the S&P 500 over the last century has been around 10%. While a particular money manager could conceivably provide a better return than 10%, nearly 90% of actively managed investment funds fail to beat the market over a 15-year (or more) time period. This means you’re likely better off investing in a low-cost index fund which will provide a higher return, on average, without spending large percentage points to have your assets managed by “professionals”, which come with high transaction fees from frequently moving in and out of positions.

 

A recent trend has been an increase in speculative investment in non-traditional asset classes like “meme stocks” and cryptocurrencies. This is evidenced by the massive growth of companies like Robinhood, often criticized as gamifying the stock market. Whether or not this is true, one thing is for certain – many retail investors are looking for ways to “get rich quick” through outsized returns by taking on substantial risk. While this might work for a select few who strike gold, it’s inevitable that most of these investors will lose money over the long term.

What if there were a way to generate great returns without so much downside risk?

Stability in Real Estate

Similar to investing in an index fund over the long term, real estate is generally considered a lower risk investment as prices tend to rise over time. While economists may offer different explanations for this, the scarcity of attractive land to build on (especially land near urban centers) inevitably increases the value of a property based on simple supply and demand principles. As a population grows, especially in areas with a lot of higher-income earners supported by a strong local economy, demand for housing will also continue to grow. Canadian home prices are forecasted to outpace inflation for years, with an expected 10-14% growth projection in 2021 alone.

Appreciation Aside…

While price appreciation is the primary upside to most securities investments, it’s only the tip of the iceberg in real estate. When you buy a stock, you’re lending your money to a large corporation with the hope that they will make prudent decisions to increase the value of their company which will, in turn, push the stock price higher. There is very little you can do to influence the stock’s value, less choosing companies with strong corporate leadership.

In real estate, each property investment is its own separate business with endless opportunities to force the value higher. Generally speaking, appreciation is a fairly insignificant factor when considering the potential upside of an investment property. What’s more important is finding opportunities to increase the property’s cash flow while keeping expenses as low as possible. Increasing the cash flow while decreasing the expenses ultimately results in a higher net operating income, which then results in a higher capitalization rate and potential sale price down the line.

Value-Add Opportunities

A property’s cash flow can be increased by finding opportunities where tenants or buyers are willing to pay a premium for a certain feature of a property without the property developer or owner having to invest a disproportionately large amount of money to offer this feature. This is where the creativity and knowledge of the developer is key – opportunities abound for those who can think outside the box. Just look at BrewDog, a Scottish brewery who began developing hotels with a craft beer tap in each room.

Beer taps are just one of many ways to increase a property’s cash flow.

For those who prefer wine, there are numerous tried and true ways in which a savvy investor can increase a property’s cash flow.

• Amenities – Common spaces which support the modern trend towards being able to live, work, and play in the same place. These amenities could increase the market rents and even provide additional cash flow. For instance, a property developer could install coin-operated laundry facilities.
• Operational Optimization – Whether buying an existing investment property or building a new one, cash flow can often be optimized by making simple changes to how the property operates. Perhaps the existing owner is paying $1,000 a month for trash removal services, when a local competitor can do it for $500.
• Add-On Development – If there is unutilized space on the site, there are low-cost structures that can be built to increase the cash flow. Storage units are a popular option, as they are in demand and offer low maintenance costs.
• Mixed-Use Development – In urban areas, creating buildings with mixed uses is a major trend. The lower floors may be dedicated to retail or office space, while the upper floors are residential. This can be appealing for the residential tenants, who have quick access to nearby shops, as well as the developer, who is diversifying their asset.
• Re-Zoning – Perhaps a parcel of land is currently zoned as commercial but is in an ideal location for a multifamily development. This parcel could be purchased at a lower price based on its zoning classification, re-zoned, then subsequently developed into multifamily units.
• High-End Finishes – Rental rates can be dramatically increased by simply providing some updated finishes such as granite countertops and stainless-steel appliances.

These potential value-add opportunities hardly scratch the surface of options available to a creative investor or property developer. A question you might be asking now is – I would love to take advantage of these opportunities for above-average returns, but how do I learn how to do this? Fortunately, you don’t have to learn all this yourself. An experienced real estate development company can help guide you through the process, allowing you to generate passive income while focusing on other business endeavors.

Our residents, colleagues and partners are at the heart of all we do. When you invest with us at TCU Development Corporation, you’re not only investing alongside us, but you’re investing in our incredible team, who work tirelessly to deliver results. Whether you’re a first-time investor or seasoned real estate expert, we’re here to maximize your portfolio, while making a positive contribution to the community. Contact us to learn more.