Value-Add Apartments: The CapEx Process

It’s no secret that I love buying class B and class C apartments and upgrading them. My real estate strategy relies heavily on purchasing apartment buildings where I can add value to their purchase price by renovating and bringing them up to today’s standards. When it comes time to adjust the rents, tenants are happy to get a newly remodeled apartment for a modest increase in rent.

I’ve partnered with Jorge Abreu on several multi-family apartment deals lately, with our most recent purchase being in Crosby Park in Oklahoma. Jorge owns over 1700 apartments on the general partnership side, and 1400 units on the LP side. But what Jorge really brings to the table is that he also owns a commercial construction company, and his specialty is capital expenditures.

Everybody doesn’t need to go out and start a commercial construction company like Jorge did, but learning how to hire a good contractor is going to make a huge difference in the cost, timeliness, and quality of your CapEx projects. For the last ten months, Jorge and his crew have been working through the renovations on Crosby Park so that we could get to the refinance point. Good contractors who can renovate on budget and on time are the cornerstone of the CapEx process, so learning to vet them is going to head off a lot of trouble on your property. 

Vetting Good Contractors

In my own experience, 10-20% of contractors are decent, 5% of them are really good, and the rest are just terrible. Knowing how to vet a contractor is going to make your project run a lot more smoothly, and while the temptation is there to hire the cheapest one around, don’t do it. What you try to save in labor costs will cost you if the project drags on forever or if it needs to be redone.

In today’s online world, if a contractor doesn’t have at least a basic website set up, then that should be a red flag to you. Websites and online reviews are a chance for you to see what other customers are saying about them, and it gives you a good look inside their reputation.

Just like when you hire for a regular job, a solid reference will help you weed out bad contractors. Ask for some pictures of their portfolio so that you can see what kind of work they produce. Talk to their past clients and find out if the job was performed on budget and on time. When you have a million dollar renovation budget, a contractor who regularly runs over budget by 10-20% could end up eating into your investors’ money, and it could damage your own reputation as well.

Crosby Park CapEx

Checking on big ticket items should be one of the very first priorities in an inspection. You absolutely want to know the age and condition of:

  • Roofs
  • Sewer lines
  • Plumbing
  • HVAC system

These larger expenses could completely sink your budget, and they’re frequently some of the deferred maintenance items that tired landlords put off until they’re ready to sell. Additionally, Jorge likes to know if past maintenance was a medium renovation or a complete renovation. That’s like the difference between gutting a bathroom and just replacing some toilets. This kind of information gives Jorge and his team a better chance to nail down just how much the CapEx budget should be.

Sometimes Jorge meets investors who like to guess on their estimated project costs. They’ll throw out the number $1.5 million because it “feels” right, but when they dig down into all of the projects they need to do, the total cost is closer to $2 million. When your guesstimate is off by a half a million dollars, you’ve jeopardized the investors’ return of principal. If you can’t execute on the business plan you put in front of the investors, then your investors aren’t going to invest with you again. Good contractors stay on budget and help you return your investors’ money. 

Renovate, Then Refinance 

When we first purchased Crosby Park, there was a 12% vacancy rate, so we had a good chunk of units that we could immediately get started on to renovate. Once we had these units upgraded and ready to lease, Jorge moved his attention to the exterior of the property. In addition to painting the entire building, he also wanted to wrap the balconies in cedar. These upgrades might seem superficial, but they really improve the feel around the whole building and they help justify the rent bump we were planning on.

Our Crosby Park purchase was $6.1 million, with a budget of $1.2 million for renovations. That puts us all in for $7.7 million. We got a bridge loan for $5.9 million, and investors added in $1.8 million. For me and all of our partners, what we’re looking for is the stabilization provided by capital expenditures.

In order to refinance, the bank wants to know how many units are occupied, and also how many units actually paid their rent. That means we have to have our renovations mostly finished, and about 90% occupancy for three months before we can qualify for an agency loan with Fannie Mae or Freddie Mac. For this project we anticipate, once you add in increased rents, an estimated value of $10.5-$11 million dollars.

CONCLUSION

If you want to confidently execute on your business plan, then you need to get your CapEx process under control. Take Jorge’s advice and find a good contractor with references who can take your project and finish on time and on budget because they know what they’re doing. 

Be daring,
Josh

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