Understanding the Difference Between Value Add and Yield Play Deals in Multifamily Investing
Investing in multifamily real estate comes with its fair share of decisions to make, terminology to understand, and strategies to digest. How we make money as multifamily investors can vary depending on the business strategy chosen for each deal. Two types of multifamily investments you’ll often hear of are “value-add deals” and “yield play deals.” While this terminology may get casually tossed around by experienced operators when pitching a deal, it can leave new passive investors unclear about what that actually means and which types of deals they should be adding to their portfolio.
It’s especially important as a passive investor to understand what you’re getting into when deciding to invest. Once you understand how the operator plans to generate cash flow, you can make a more informed decision on what types of deals best fit your financial goals and risk tolerance.
Our goal is always to help you make educated investing decisions that will help you make progress towards your financial independence goals. In this article, we’ll break down the differences between deals using the value-add vs yield play strategy and how they are implemented so you can make smart investing decisions for wherever you are in your journey.
Value Add Approach
A value-add deal is exactly what it sounds like - adding value to a property in order to raise the net operating income. Using the value-add method, multifamily property owners typically focus their business plans on some sort of renovation that increases the property’s appeal, justifies a rent increase, and ultimately increases the property’s value. The value-add strategy is often executed on class B or C type buildings because these properties have more opportunity for improvement. There is typically not much more to improve on for nicer Class A properties.
Creating a safer, convenient, and more enjoyable atmosphere for residents adds value to their lives and while helping operators create more value in the property. There are lots of ways to add value to properties, both within the individual units and in the common areas of the property itself. Renovations to units might include updating countertops, replacing flooring, re-painting walls, and upgrading appliances. Value add renovations that can improve the overall property might include building a playground, creating a dog run, or making parking spaces covered.
A value-add scenario does not always involve renovations, however. You may hear the term “re-tenanting” used by investors to increase the desirability of a multifamily building. Re-tenanting is typically aimed at reducing vacancies and delinquencies by removing troublesome renters when absolutely necessary. We always encourage operators to first work with problem renters to find amicable solutions. Ultimately, the goal is to ensure that the living environment is safe, welcoming, and enjoyable for the community.
Whether your plan involves renovations, new amenities, re-tenanting, or a combination of the three, adding value to multifamily housing involves proper planning and execution. The value-add method is often considered riskier, as more work and planning are involved. This strategy also makes the property attractive for future buyers as long as you leave enough “meat on the bones” or room for the next owner to continue to increase NOI.
When vetting operator plans for value add deals, make sure they have explicitly shared what projects they will be executing at the property, including how many units will be renovated and a reasonable budget to complete the projects. This will allow you as a passive investor to understand the value that will be created and if they have thoroughly thought through how they plan to make money while they own the building but also their exit strategy when it comes time to sell.
Yield Play Approach
The yield play approach is typically used for “nicer” assets such as Class A properties. The term yield play comes from the concept that the property is “yielding” a cash flow when you purchase it. Typically any major renovations have already been done so investors are buying it with the intention to hold on to the property and let it cash flow. They may make minor changes like upgrading utilities to high speed fiber optic cable or focus on reducing operating expenses to drive additional value.
Yield play deals are typically seen as lower risk investments because they do not require the same level of complexity as managing a deep renovation on multiple units as you might see in a value-add investment. That does not necessarily mean that they should be overlooked in favor of value add projects, though. Operators can still increase the NOI by lowering expenses and keeping on top of market rents. Although the physical changes to the property will be minimal after the purchase, the property’s value can still be increased. Having some yield play deals in your portfolio is an excellent way to offset the risk that can come with value add projects. They can also provide stable cash flow from the onset if, as a passive investor, your financial goals are more focused on cash flow vs. building wealth through large equity gains.
Hybrid Approach
It’s not always an all-or-nothing situation when it comes to deals. Many operators may choose an approach that combines both of these strategies. There doesn’t have to be a hard line in the sand separating value-add from yield play deals. Many investors look to find a multifamily property that already has a decent yield then execute smaller scope value add projects to increase the current NOI and overall property value.
You may see business plans that combine these two strategies in various ways. Owners will purchase a property that requires a moderate amount of value-add to yield additional cash flow, then use a cash-out refinance, continuing to hold the property but using the money to purchase another multifamily building. The original property becomes their “cash flow cow” while moving on to the next value-add deal, rinsing and repeating the cycle.
Value-add deals offer endless possibilities for a higher return on investment but also bring a higher risk component. Yield play deals are great ways to create a straightforward and consistent income stream with a low-risk factor. Smart investors typically own portfolios with a mix of different approaches that are best tailored to each property. A diverse multifamily investment portfolio will allow you to grow your wealth while reducing risks along the way. What’s most important is to understand which approach the deal you are investing in is using, ensure the operator has a clear business plan that makes sense for the property, and evaluate how the deal fits into your own investment strategy and will contribute to your financial goals.
You Might Also Like:
