December 22, 2022

JF3031: Why Value-Add Business Plans Make the Most Sense | Passive Investor Tips ft. Travis Watts

Passive Investor Tips is a weekly series hosted by full-time passive investor and Best Ever Show host, Travis Watts. In each bite-sized episode, Travis breaks down passive investor topics, simplifying the philosophy and mindset while providing tactical, valuable information on how to be a passive investor.


In this episode, Travis discusses how, as a passive investor or limited partner in a syndication or real estate private placement, you must first decide which asset class(es) you want to invest in. However, you also have the freedom to choose what business plan you want to partner in when it comes to those asset choices. 

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Travis shares why the bulk of his portfolio is heavily focused on value-add business plans, and why he refers to this type of plan as his “bread and butter.”



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Travis Watts: What's up, Best Ever listeners? Welcome back to another episode of Passive Iinvestor Tips. I'm your host, Travis Watts. In today's episode, we're talking about why value-add business plans make the most sense; the most sense for who? Well, at least the most sense for me. As always, not giving you financial advice, not telling you or anyone what to do. Please seek licensed advice. This is always educational purposes only.

So in this episode, we're kind of honing in and we're talking about mostly the topic of being a passive investor, or being a limited partner in syndications, or real estate private placements. So when you're a limited partner, you get the choice to decide, first of all, what asset class you want to invest in. There's multifamily, self-storage, industrial, mobile home parks, hospitality, hotels, car washes... So you also get the freedom of choice to decide what business plan you want to partner in when it comes to those asset choices, such as new development, new construction, luxury, opportunistic, which means that often they'll have major issues or be in a less desirable area and you'll have a lot of hurdles to tackle and try to turn something around, with a lot of work, time and effort... Or you have value-add, which we're going to talk about a lot in this episode, or you have core, and core plus, or what some people might refer to as turnkey business models, where all the renovations have been done, tenants are in place, occupancy and collections are high, and you're just buying something pre-existing, with little to no deferred maintenance, so that you can just ride on the cash flow in the market.

So with that said, I do pretty much all of those things, with the exception of new development... But I want to share with you why my bread and butter and why the bulk of my portfolio has been heavily weighted on value-add business plans. And value-add can be simplified by just saying that we're buying something that's pre-existing, we're fixing it up, we're modernizing the efficiency, and the units, and the clubhouse, and the amenities, to use multifamily as an example... We're making it a better place, and then we're looking to resell it once we're finished with that business plan. And you can relate this to really a lot of different things in life.

The parallel I like to draw is on cars; you could do the same thing, right? So a value-add opportunity or a business plan with a car, I've done before. I did this with a Porsche Cayenne years ago that I bought really cheap, put some miles on it, fixed up a few things, and then ended up selling it... Or a better example is my wife's Lexus, which we bought, I want to say in 2019-ish, and it had 150,000 miles on it, a little Lexus Hybrid four-door car. We paid $6,000 for it locally. It was miss-marketed; it had a few issues with it. We bought it we fixed those issues on the cheap, she ended up putting 25,000 miles on it over the course of the next few years... We actually rented this car out using an app and a platform, and made about $2,500 net off of that. And then recently, I just listed it and sold it for $8,000. So we actually turned a profit, used the car for 25,000 miles, and pocketed some rental income in the process. That is an example of value-add.

So I've really been inspired since about 2015 and '16, when I first started really getting into the being a limited partner in these syndications with this concept of value-add. I was raised with those types of beliefs, that you want an armoire or a chaise lounge in your house or something, you buy it used, you make it look nice, you freshen it up... We used to do this with leather furniture as a kid... And then we can sell it at a profit, after using it for our own purposes.

And even before I got into multifamily syndications and being a limited partner, I spent six and a half years doing value-add on single family homes, and condos, and townhomes, whether it was a home I was buying to live in, and I was having a roommate or something, meanwhile I was fixing up the property and selling it for a profit later... Or with fix and flips, or with vacation rentals, or with my buy and holds... I've always really focused on this value-add segment. And I want to compare that now to something like new development. And it's not to suggest that you can't make money doing new development. In fact, a lot of people have. But if we take the same parallel between cars and real estate real quick, and you think, okay, if you're buying a brand new luxury apartment community that's already been completed and leased up and has top market rents, you're probably not going to be getting a big discount on it, because that's a highly demanded product, and pretty much you can get top dollar.

So if you go into that, as an investor, you're more reliant on the market conditions to lift your rents moving forward. In other words, there's really no deferred maintenance; there's really nothing you can add to a brand new community, or in the case of a car, you buy a brand new car - you're probably not going to get a large discount on one these days... And there's nothing you can really do to improve it. You can't put a backup camera, or navigation in, or change the displays, or upgrade the sound system. It already has all the bells and whistles. So if you're going to try to make money at a new car, it is possible.

For example, electric cars right now - there's a long wait list for a lot of them, so what some people have been doing is they'll order a car, let's say 6 to 12 months ago, have it delivered, use it for a little bit, claim their tax credit, if there is one that's applicable, and then sell the car, sometimes at a profit. And the reason is, again, it's market conditions; it's simply supply and demand. If somebody wants a brand new Tesla, whatever, in the color red, with the upgraded wheels, that could be six to eight months out if they go online and place an order. But if I have one that they can drive home today, I might be able to jack that price up and make a little bit of a profit. But again, keeping in mind, that is market dependent. Eventually, if you can go straight to a Tesla dealership and walk away with virtually any car you want, then that stops working. And this is why I love value-add.

Break: [00:08:04.16]

Travis Watts: So now let's talk for a minute about C class and D class apartments. These are usually much older, vintage products, 1950s, '60s, '70s. And we have to remember, you might get a discount, so to speak, on the purchase price when you look at the per-unit cost, but it's because these are less desirable properties. a) Because they're older, they often have a lot more deferred maintenance, or it may be classified as a C or D because it's in a less desirable place. So with that in mind, you have to remember that when you go to exit those deals, you're not going to have as many buyers on the backend. In other words, a lot of institutions aren't even looking at those classes, because they're looking for the newer, remodeled, turnkey, class A and class B product type.

So I draw this parallel to something like the car I drove in college was a 1995 Honda Civic. Well, it was an older car even at that time, and it lacked a lot of modern luxuries and conveniences. It had no navigation, it had no backup camera. In fact, it didn't even have air conditioning in the state of Florida. And it's because I believe it was originally sold in a colder climate, somewhere like Maine, or something like that, where A/C is just not something that appeals to a lot of people buying cars, apparently; at least in 1995, or so I hear.

So that's why I was able to buy it for cheap; it seemed like just such a bargain at the time. I forget exactly what I paid, but it was very, very low numbers. But then I had to remember that when I went to sell that car, it's still a 1995 Honda Civic, with a ton of miles on it, it was manual transmission, it had no air conditioning, and now I'm selling it in Florida. So that was a really tough sale. I don't know if I ended up breaking even or losing a little bit of money on it. But again, it's not to say I couldn't have made money on it, it's just that you have to always keep in mind that's a less desirable product type.

Back to an apartment example of a C or a D class - there's not much you can do, if you think about it, to a 1970s original vintage product, that has eight foot popcorn ceilings, and it's full of one-bedroom units that are 600 square foot. You can't really expand those units, unless you want to have less units on the property... And you can scrape popcorn ceilings all day long, but at the end of the day, you look at it and you say "That looks like a 1970s apartment building." So to a prospective renter, that's what it is. And so now, today, people are looking for home offices, they're looking for the second bedrooms; people are starting to, because we're entering into recession, double up with people and split rent. Well, that just doesn't work in an old product type like that. Again, I have invested in those product types, not saying you can't make money in them, but it's kind of a higher risk/higher return kind of scenario.

So Passive Investor Tips is all about making these episodes short and to the point, just little snippets, things to think about for the week... So I'll end with this - when you do value-add as a business plan, it gives you a little bit of wiggle room and margin. And what I mean by that is most of the deals I partner in, we're buying the complex, the apartment building about 200 below market rents today. And it's because they're older and outdated, but they have the potential for the value-add business plan to compete with more modernized buildings and amenities.

So for some perspective, 2008, 2009 and 2010 class B multifamily rents fell about $125 per month at the absolute worst of the Great Recession. So if we can just get through, let's say roughly 50% of our business plan, then we have a cushion to withstand some of the volatility, some of the uncertainty, the rising interest rates, things that are inevitably going to pop up, like kitchen fires, or floods, or tornadoes. It's real estate, guys; it's reality. It's a people business, so things are going to happen.

I've always felt a little comfort in sleeping at night, knowing that if we just get a little bit through the business plan, we've got that cushion to fall back on if we do have to stagnate our rents, or even bring them a little bit back down... We've hopefully been able to at least modernize and enhance that community to make it more desirable, to justify the rent lifts, or at least the stabilization of the rents.

So with that, I'm going to keep it short on this episode. If we haven't connected - Facebook and Instagram is @passiveinvestortips. Bigger pockets, LinkedIn... I'm all over the place, Travis Watts. Let's connect. Happy to be a resource for you. If you want to 15-minute Q&A call, you want to dive deeper. I've got nothing to sell you, I've got a lot to give. I appreciate the comments, the feedback, the support. You guys really seem to be liking this segment. I love doing this segment, and it's been the most fun that I've had so far here at Best Ever... So thanks so much for your support, everyone. Have a Best Ever week, and we'll see you on the next episode.

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