Defining Multifamily Redevelopment
Tactica’s newest financial model handles redevelopment investment opportunities. It’s becoming apparent that although our Value-Add Model and Development Model are beneficial for most underwriting situations, certain investments need more of a hybrid underwriting tool—thus the Redevelopment Model.
Multifamily Definitions
Let’s first dive into Tactica's definition of Value-Add and New Development investing, as they will help us unearth some of the shortfalls in modeling a proforma of multi-housing redevelopment.
Value-Add
A value-add investment strategy is an existing apartment building that needs a cosmetic overhaul on unit interiors and potentially common areas. In most instances, the property is not distressed, meaning there will be significant revenue from the original units as the rehab schedule commences. The methodical nature of renovations (selectively renovating when leases expire) will typically lead to a linear renovation schedule where premiums are phased in gradually over a multi-year period.
The historical financials are usually bankable (meaning you can make proforma assumptions from them). Obtaining agency financing is usually not a challenge (although lenders will not give credit for rental upside when pricing the deal).
While a refinance may be possible in the future, it is not a certainty as investors will often put on long-term agency debt at purchase and fund the renovation capital budget with a combination of equity and cash flow.
Development
A development investment strategy could be constructing a multifamily building “ground-up” or repurposing an old structure for habitable units (such as an old warehouse or office building). Unit lease-up will commence only after the construction is complete and the property is issued a certificate of occupancy.
Most developers will use a construction loan and a combination of equity to fund the land purchase/construction and refinance into longer-term debt once the property is stabilized. Because there is no cash flow early on in the investment hold, an interest reserve is necessary for the borrower to pay the required monthly interest-only payment.
Ideally, they would pay back investors a portion of their initial equity contribution with refinancing proceeds.
Redevelopment Definition
I consider a redevelopment investment strategy for a distressed multifamily property that requires total repositioning. You’re unlikely to be able to get agency financing on a project like this due to weak financial trend lines. The property may also have glaring capital defects or other functional obsolescence and would require a sophisticated capital schedule. No agency lender would likely give funds on a project of this nature.
Short-term construction or bridge financing is likely the only debt option to secure a property like this. Therefore, renovations will take place swiftly. Operators may renovate an entire building, floor, or wing simultaneously, trying to vacate all leased units as expeditiously as possible, potentially even paying residents to terminate their lease term early. Owners may even want to get as granular as forecasting each unit at the property but can also underwrite a more expedited repositioning strategy for larger apartment complexes. Key assumptions will revolve around the renovation inputs:
Rehab start month
The cost to convince a tenant to vacate (if cash for keys is prevalent)
The rehab duration (in months)
The lease-up timeframe (in months)
Lease-up concessions (if any)
Occupancy assumption pre-renovation
Occupancy assumption post-renovation
Rental increases post-renovation
Speed of execution is exponentially more important than property revenue during the rehab timeframe. Time is money, as the owner must finish before the construction debt balloons. The earlier the refinance, the more beneficial to time-sensitive investment metrics such as the IRR.
As units, floors, and building wings are completed, ownership can lease units up before the entire project is complete (unlike a ground-up development). There also may or may not be income flowing in from residents living in the vintage units that have not yet been renovated (like there would be in a value-add project)
Upon completing the extensive repositioning effort, the owner will refinance out of the short-term (likely more expensive) bridge/construction debt, put on long-term agency financing, and hopefully pay back investors a portion of their initial equity contribution with refinancing proceeds.
Related: The Redevelopment Model is also an excellent tool for adding additional units or combining smaller units into larger floorplans.
Similarities Between 3 Strategies
As you’re probably realizing, a redevelopment investment strategy has components of both value-add and development. It also possesses unique elements that make it more of a “hybrid” strategy. Tactica’s model takes pieces from our tools and tailors them for this investment strategy's uniqueness.
Redevelopment & Value-Add
Potential for revenue during the construction period
Historical financials and current rent roll are important for proforma underwriting
Renovation premiums
Related: Review the key differences between the Value-Add and Redevelopment Models
Redevelopment & Development
Construction financing is likely necessary
Interest reserve (potentially for redevelopment)
“Construction Budget” and “Draw Schedule” are crucial
Unit lease-up schedule
All Three Strategies
Proforma unit mix/rental assumptions (likely influenced by local rent comps)
Proforma operations assumptions for other income and operating expenses
Returns summary (IRRs, equity multiples, cash on cash returns, yield on cost)
Partnership Distribution Structure (GP/LP splits and promote structures)
Determining The Best Fit
The questions you must ask yourself are:
Will this project require a short-term bridge loan that you must refinance?
Do you want more granular control over the renovation schedule (dictating which units you are renovating each month instead of underwriting a linear progression of premiums being phased in)?
Do you want more precise control over when common area/deferred capital spending occurs?
If the answer is “Yes” to any of these questions, the Redevelopment Model will likely be a good fit for your business plan.
Summarizing Multifamily Business Plans
Below is a Venn diagram summarizing the text from the paragraphs above for visual learners. It details how Value-Add, Development, and Redevelopment strategies overlap and their uniqueness.
The Redevelopment Model is an intricate financial modeling tool that captures essential components from both Tactica’s Value-Add and Development Models, along with its own unique facets that distinguish this type of real estate investment strategy.
