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  • Writer's pictureMack Benson

What Is A Value-Add Apartment

The real estate industry is chock full of buzz words, for example when buying a new home your agent may talk about a house being turn-key or move-in-ready, on the other hand you could also find a home that needs some TLC and could be referred to as a fixer-upper. When buying a new home everybody has their own preference, do you want to move in and not have to worry about a thing but have fewer options for building equity. With the fixer-upper you will have more things to do to make the home how you want it but you also have a lot of options to increase its value by putting work into it.

In apartment investing we have similar concepts for our investments, on one end of the spectrum you have the turn-key investment where the property is updated and modern systems are in place and the management is among the top performers. Conversely you find the value-add property which would be similar to single family fixer-upper. With a value-add property you are able to increase the value of the property by either decreasing its expenses, or increasing its income to increase its cash flow. At Infinite Focus Capital our specialization is investing in mom and pop multi-family apartments with a value-add component. But what are these value-add components and what does it mean for an investor? Increase Income We follow a simple three step system for increasing the income of a property and we begin implementing our strategy as soon as we take a property over.

Step 1: Fill vacant units at market rent Many mom and pop apartment operators have owned their property for years or even decades and frequently have low or no debt so they are not as concerned about keeping vacancies low as we are. At take over our first priority is to fill the vacant units at market rate. A vacant unit will not help us increase our cash flow so we need to get a paying renter in there as soon as possible. Our first step to filling the vacant units at market rate is to renovate the empty units to a modern paint scheme and perform other cosmetic updates including flooring, cabinetry, appliances, and counter tops. The two most important rooms to a renter is the kitchen and the bathroom so that is where we devote most of our efforts. After we have renovations complete on a unit we will take pictures of the freshly renovated unit and post them online to immediately begin generating interest and start accepting applications. After we renovate and fill the vacant units we will address any deferred maintenance noted during our due diligence and begin working on exterior and common area updates. The exteriors of mom and pop apartments often have not been maintained and the landscaping is in dire need of attention. Landscaping is a low hanging fruit which can easily be taken care of and if not maintained can be a deterrent to high quality prospective tenants. Common areas also tend to see a lack of maintenance in these properties so we will give them a facelift with new lighting, paint, and flooring; paying special attention to hallways and laundries. As we lease up the newly renovated units at market rent we will also institute our fee system on any newly lease signed. This includes application fees, move-in fees, late fees, pet fees and more. Step 2: Implement RUBS After we have filled the vacant units with renters at market rent we can begin implementing RUBS (Ratio Utility Billing System). For this we contract a third party vendor to systematically charge the tenants for utilities paid for by the landlord based on an estimated tenant usage. This is a huge revenue generator and can help offset between 75% and 80% of our utility cost. One thing we are very careful of with our RUBS is to not charge our tenants more than pay. If we have a markup over our cost we could be considered a utility company by the state and regulated as such or we could face fines. That is why we stick to the 75% to 80% goal. Implementing RUBS takes a bit longer than filling the vacant units so we plan on fully implementing this step within about 6 to 12 months of taking over a property. This is because we need to wait for lease renewals to institute the policy and leases expire throughout the year. Step 3: Raise remaining rents to market level The third step in the framework is to raise the rent in the remaining units to market level. Not having units rented at market level is on of the main downfalls in mom and pop operators. One of the reasons this is the final step is because we want the property stabilized first. We do not want to be in a position where we have a high tenant turnover while we are leasing up the vacant units. Trying to handle both at the same time would be difficult on our cash flow unless this was part of the original business plan for the property. We try to work with tenants to either renovate their unit with them in it or help move them to one of our previously renovated units. More often than not, when they see the new units we are providing, tenants ask if they can move on their own at their lease renewal. Decrease Expenses As with any business it is often easier to exhibit control over your expense than it is to control your income. We tend to focus our efforts on a few different areas to decrease our expenses.

Operational efficiencies Many mom and pop owners do not have systems or processes in place and this can lead to potential income not being realized. We like to charge a move-in fee rather than hold a security deposit. By not holding a security deposit we are avoiding possible points of contention during a tenants move-out and we also do not need to worry about paying the tenant a correct amount of interest which is in alignment with the laws in Minnesota. Another area many mom and pop operators frequently miss is pet fees. We see quite a few operators who do not allow pets in their properties at all. We feel different and charge a pet application fee as well as a monthly pet rent fee. We feel this usually more than makes up for damages and extra cleaning at turn. Plus by allowing pets we greatly increase the potential tenant base. Utility savings We like to save on utility costs by installing efficient fixtures whenever possible. This includes upgrading the common area lighting with LEDs and in units we install low flow water fixtures. We ensure that the mechanicals in our properties are properly maintained so they stay at peak efficiency. By implementing RUBS we have found that tenants become more cognoscente of the amount of water and electricity they are using because they pay a portion of the monthly bill, they are also more likely to report leaks for this very reason. Contracts When we take a property over we review all contracts and ensure that all have the best terms possible. Garbage companies are notorious for price creep so we will shop for the most cost effective trash hauler in the market. In some markets the local cable TV operators will offer a contract or a kickback to be the exclusive cable provider larger properties, this can be quite a lucrative option and can both increase your income and decrease your expenses. Maintenance Deferred maintenance is a huge way to cut expenses. Maintaining a property quite often far less expensive than having to repair something in an emergency situation. Take for example if the heat goes out at a property in Minnesota in January. By law you need to provide heat to your residents so this could be a valid reason to lodge a complaint if not rectified within a reasonable amount of time. If it is an emergency situation you could very well be in a situation where you have to pay up to five times the normal rate. While routine maintenance will not proactively prevent every problem it does a great job finding most problems before they come to a head. Conclusion Commercial properties are valued based on their net operating income or NOI. We seek out mom and pop operators who often times lack the controls and processes to maximize their income while minimizing their expenses. By instituting our value-add tactics we increase the value of the property while providing an exceptional product for our tenants.

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