Imagine spotting an old bookshelf sitting out on the curb. You pull over to check it out, and since it’s in good shape, you proceed to lug it home and give it a fresh coat of paint. 

A few years later, you sell the shelf to someone else who claims to have the perfect spot for it.

You took something that had been overlooked, committed some sweat equity, and breathed new life into it. This is the essence of value-add, and it’s a commonly used strategy in real estate investing. 

The Basics of Value-Add Real Estate

In the case of single-family homes, the process of buying a run-down real estate investment property, remodeling it, and then selling it for profit, is commonly referred to as fix-and-flip. Your sweat equity and ability to see a diamond in the rough is rewarded monetarily, and the new owner gets an updated, move-in ready home. 

Value-add commercial real estate deals follow a similar model, but on a massive scale. Hundreds of units get renovated over years instead of just one single-family home over a few months. 

A great value-add hotel investment property may have peeling paint, outdated common spaces, or overgrown landscaping, which all affect the curb appeal and the initial impression that guests will form. Simple, cosmetic upgrades can attract more qualified guests and increase the income the property produces. 

In value-add real estate properties, improvements have two goals:

1. To improve the property and the community (positively impact guests)
2. To increase the bottom line (positively impact the investors)

Value-Add Examples

Common value-add real estate renovations can include upgrades, such as:

• Fresh paint
• New furniture
• New bedding
• New appliances (refrigerators, microwaves, coffee makers)
• New flooring
• Upgraded fixtures

In addition, adding value to exteriors and shared spaces often helps to increase the sense of quality:

• Fresh paint on building exteriors
• New signage
• Landscaping
• Dog parks
• Gyms
• Pools
• Playgrounds
• Covered parking
• Shared spaces (BBQ pit, picnic area, etc.)

On top of all that, adding value to a hotel property can also take the form of increasing efficiencies:

• Green initiatives to decrease utility costs
• Upgraded cable and internet
• Reducing expenses

The Logistics of a Hotel Value-Add

The basic fix-and-flip of single-family homes is pretty familiar to most people, but when it comes to hundreds of guest rooms at once, the renovation schedule and logistics aren’t as intuitive. Questions arise around how to renovate a hotel property while people are staying there and how many rooms can be improved at a time. 

When renovating a hotel, the vacant rooms are first. In a 100-unit complex, a 10% vacancy rate means there are 10 empty rooms on average, which is where renovations will begin. 

Once the first 10 rooms are complete we just move on to the next 10 rooms.  New guests are offered the choice to move into the freshly renovated rooms. They are usually more than happy to pay a little extra for the nicer space or if they are value conscious consumers they may prefer the non-renovated space at the lower price.

Why We Love Investing in Value-Add Real Estate Properties

When done well, value-add investment strategies benefit all parties involved. Through renovations, we provide guests a more aesthetically pleasing property, with updated amenities and more attractive community space. By doing so, the real estate property becomes more valuable, allowing higher nightly rates and increased equity, which also makes investors happy. 

The idea that a renovated real estate property is more attractive to guests is pretty intuitive. But let’s dive into why value-add real estate investing is a great strategy for investors.

First, Yield Plays

To fully appreciate value-add real estate investments, we must first understand their counterparts, yield plays. In a yield play, investors buy a stabilized asset and hold it for potential future profits. 

Yield play real estate investments are where a currently-cash-flowing-property that’s in decent shape is purchased and held in hopes to sell it for profit, without doing much to improve it. Yield play real estate investors hold property in anticipation of potential market increases, but there’s always the chance of experiencing a flat or down market instead. 

In a yield play, everything is dependent upon the real estate market.

Now, Let’s Get Back to Value-Adds

Value plays and yield plays are the opposite. In a value-add real estate investment, significant work (i.e., renovations) takes place to increase the value of the property and doing such improvements carry a significant level of risk. 

However, value-add real estate investment deals also come with a ton of potential upside since the investors hold all the cards. Through physical action steps that improve the real estate property and increase its value, value-add real estate investors don’t just hold the asset hoping for market increases. 

Through real estate property improvements, income is increased, thus also increasing the equity in the deal (remember, commercial real estate properties are valued based on how much income they generate, not on comps, like single-family homes), which allows investors much more control over the real estate investment than in a yield play. 

Of course, a hybrid yield + value-add real estate investment is ideal. This is where an asset gets improved as the market increases simultaneously. Real estate investors have control over the value-add renovation portion and the market growth adds appreciation. 

Now, before you get too giddy about the potential of a hybrid real estate investment, there are risks associated with any value-add deal. 

Examples of Risk in Value-Add Real Estate Investments

In hotel value-add real estate investments, common risks include:

Not being able to achieve target nightly rates 

Lower than expected occupancy rates

Renovations running behind schedule or renovation costs exceeding initial estimates (which can be a big deal when you’re renovating hundreds of rooms)

Risk Mitigation

When evaluating real estate investment deals as potential investments, look for sponsors who have capital preservation at the forefront of the plan and who have a number of risk mitigation strategies in place. These may include: 

• Conservative underwriting
• Proven business model (e.g. Hybrid Housing or micro-apartments)
• Experienced team, particularly the project management team
• Multiple exit strategies
• The budget for renovations and capital expenditures is raised upfront, rather than through cash flow

Value-add real estate investments can be powerful vehicles of wealth, but they also come with serious risks. This is why risk mitigation strategies are important – to protect investor capital at all costs.

Recap and Takeaways

No real estate investment is risk-free. However, when something, despite its risks, provides great benefits to the community AND real estate investors, it becomes quite attractive. 

Properly leveraging investor capital in a value-added hotel investment allows drastic improvements in properties, thereby creating cleaner, safer places to stay and making guests happier, which increases occupancy rates and cash flow.

Because real estate investors have control over how and when renovations are executed, rather than relying solely on market appreciation, they have more options when it comes to safeguarding capital and maximizing both passive income and real estate investment returns. 

Sounds like a win-win!