The problem with buzzwords in the world of investing is they replace sound decision-making with decisions based on hype.
Remember the buzzwords that dominated last year? Crypto and meme stocks were generating a lot of investor attention—along with their money. Flush with stimulus money, newbie investors flooded the markets, snatching up anything that was attracting attention on internet forums and social media. Investors snapped up crypto and meme stocks based purely on buzz.
Dogecoin, a cryptocurrency that started as a practical joke, was flying high about a year ago. But since its peak last summer, it has dropped more than 740%. Gamestop, a meme stock that made waves last winter fueled by online buzz, has fallen 167% since the peak of the hype last December.
If investors had done their homework when analyzing the prospects of Dogecoin and Gamestop instead of relying on buzz, they would have realized Dogecoin was a joke currency and Gamestop’s momentum was fueled purely by artificial hype rather than any underlying economic factors.
Likewise, they would have realized the Gamestop price spike was artificially created by a group of investors bent on teaching the hedge funds a lesson. They combined forces to drive up the share prices of flailing companies targeted for short selling, causing hundreds of millions of dollars in losses when these hedge funds were forced to cover those shorts at high prices. Once the buzz died down, the crash was on.
The Buzz About Value-Add
In the world of real estate investing, a buzzword currently making the rounds is causing investors to forget the basics of deal analysis and leading them to ignore the financial data and underlying economic fundamentals essential for projecting the prospects of a deal.
That buzzword is “value-add.” Like crypto and meme stocks, the word “value-add” implies a “can’t miss.” As a result, investors act carelessly.
Investors assume any opportunity associated with the word “value add” is a slam dunk. However, in the wrong hands, a value-add investment carries high risk like any other investment. These investments are anything but “can’t miss.” In fact, investors could lose more money with these deals than if they had stuck with a more conservative investment strategy.
Value-add investments, when done correctly, can build wealth. As the name implies, a value-add opportunity is one in which an investor can make substantive renovations to the asset or changes to management efficiencies and add value to an investment to generate higher returns than more conservative strategies like core and core-plus, which require few modifications to the property.
Investors acquire commercial real estate for constituent cash flow and long-term appreciation. Value-add opportunities allow investors to boost both cash flow and equity through strategic improvements in appearance, amenities, and management efficiencies.
Although value-add investments come with outsized upside, they can also potentially come with huge risks.
When Value-Add Becomes Value-Loss
A value-add opportunity can become a loser under multiple circumstances, including overpaying at acquisition or underestimating costs post-acquisition. Overpaying and cost overruns diminish the returns you once projected.
Value-add opportunities get all the hype, and everyone wants to get involved with them. Still, there are two misconceptions to remember when evaluating value-add opportunities versus other opportunities:
- Misconception #1 is that all risks associated with value-add investments are minor and can be overcome easily.
- Misconception #2 is that other strategies such as Core and Core-Plus can’t compete with value-add assets.
Misconception #1
The idea that all risks associated with value-add investments are minor and can be easily overcome is false. There are many risks, both external and hidden, that can get out of hand
and end up being prohibitively time-consuming or costly to remedy or mitigate. Risks involved with value-add investments include:
• Rehab running behind schedule.
• Overrun on material costs.
• Unplanned labor costs and issues.
• Disasters occurring during renovations (e.g., striking a water main or gas line).
• Natural disasters.
• Troublesome tenants.
• Unsavory elements moving into the neighborhood or neighboring communities.
• Not achieving target rents.
• Inability to reduce vacancies or unexpected increase in vacancies.
• Rehab costs exceeding estimates.
• Undetected foundational or structural issues.
Misconception #2
Another misconception surrounding value-add opportunities is they are the end-all-be-all of real estate strategies—core and core-plus opportunities be damned.
When value-add properties get mired in problems, they’re no longer the “value” an investor thought they were. A solid core or core-plus opportunity seems relatively favorable compared to value-add properties caught in those circumstances.
Core/Core-Plus Vs. Value-Add
So, what’s the difference between core and core-plus properties versus value-add?
- Core properties have high occupancy (90% or higher); generate stable, consistent cash flow from established, high-quality tenants locked into long-term leases; are located in prime locations; and require little to no upgrades.
- Core-plus properties are similar to core properties, but they offer the opportunity to improve cash flow through slight property, management, or tenant improvements.
When handled properly, value‑add properties have the potential to generate above-average gains. And, if they perform exactly as projected, they will outgain other investment strategies.
That doesn’t mean investors should ignore core and core-plus properties. They can prove valuable in any portfolio as a consistent and reliable cash flow source. Compared to underperforming value-add properties, core and core-plus properties have the potential to outperform value-add properties but without the risks or headaches.
The success of a real estate investment comes down to deal analysis, data, and numbers. It doesn’t matter which strategy you pursue. If you rely solely on buzzwords and fail to do your homework, your investment will fail. On the other hand, if you dot all your “i’s” and cross all your “t’s,” you can make money from just about any strategy.
Kyle Jones is the founder and key principal of TruePoint Capital, LLC, a private equity firm focused on owning and operating value-add multifamily assets and ground-up construction. Jones is responsible for overseeing all aspects of the company’s financial activities, operations, and investor relations.
In addition to TruePoint Capital, LLC, Jones is a co-founder of American Grid, which is a residential appraisal management company.
Before becoming a full-time investor and entrepreneur, Jones worked for multiple Fortune 100 companies and in the high-tech sales industry.
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