One of the best aspects of investing in multifamily properties is the ability to force appreciation… But what does that mean?
In this week’s bonus episode, Dan is going to break down forced appreciation, what it is, how it works, and even use an example property to walk us through the process.
This is another episode that you should definitely check out on YouTube because Dan is breaking out the ol’ spreadsheet!
Wouldn’t it be great if there was a really black and white, quantitative way of being able to forecast the value of the property?
Find out how, and more, in another bonus episode of Multifamily Investing Made Simple!
“Once you wrap your head around how the valuation works and how the forced appreciation value add model works, I think everything else just starts to click.” – Dan Krueger
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Forced Appreciation Screen Share
[00:00:00] One of the best aspects of investing in multifamily properties is the ability to force appreciation. But what the heck is forced appreciation and how do we actually do it? That’s what we’re diving into in today’s video. Let’s get into it.
Hey, what’s going on is Dan Kruger, Invictus capital. And today we’re going to be talking about forced appreciation what it is and how we do it. We’ve effectively been doing the same thing over and over here at Invictus capital for a long time. Now we find good quality multi-family properties in the Minneapolis St.
Paul Metro area that have upside potential, which means. That we can go in and we can add value to the property and we can make it better. And that’s going to directly correlate to the value of the property, unlike in the smaller properties, like a single-family house, or even a duplex triplex, or a quad where you’re hoping that the market is going to improve, and that you’re hoping that you make all this investment and dump all this money into a property that the market doesn’t go the other way.
That is a, is a risky situation in why I never really got into the smaller properties. Personally. I was extremely drawn to the valuation model in the larger multifamily space, which is, uh, particularly [00:01:00] focused on the income that a property produces to derive the value of that property. Much less subjective it’s muscle, much less emotionally driven, uh, than the smaller property than that market is.
And it gives us something that we. Uh, forecast with a lot more confidence and that really spoke to me and that’s a really got me excited. And then. So today we’re going to dive into exactly how this works so that you can understand why this investment strategy and why this asset classes, in my opinion, one of the best out there.
So for the sake of this, uh, explanation, I put together a brief little, uh, summary, or I should say an example of what a deal, uh, typically looks like that we might do this. Isn’t a real deal. You know, just made up numbers, uh, but the return projections and the, the, the, the appreciation that we’re going to take a look at in this example is right on par with the stuff that we’re doing every day.
So let’s dive into it here. Uh, so right off the bat, we have a 30 unit building. Uh, now this is [00:02:00] priced at about $115,000 per door. And, uh, so that’s going to imply that this is a C plus B minus class asset, meaning maybe mil, mid century, uh, Mid sixties, seventies, maybe eighties, something like that. Um, and right now the rents are sitting at about $900, but the rest of the market for comparable properties is charging 1150.
Now that’s, what’s going to catch our eye. Initially when we see that big Delta between the in-place rents and what the rest of the market is doing, that tells us that there’s an opportunity for us to go in here, improve the property, make it safer, make it prettier, make it a better living environment for the residents and in turn.
Increase the rent as people move out. Now we don’t just Jack the rent up on people. When we buy a property, we wait for people to organically move out and then we go in and we improve the unit, uh, primarily by upgrading kitchens and bathrooms. Uh, that’s where a decent amount of money is spent. And there’s typically going to be some common areas, stuff that we do as well.
But for this example, we’re keeping it simple. [00:03:00] We’re going to be spending about $7,500 per year. Upgrading kitchens and bathrooms. Uh, maybe some light fixtures, a little bit of fresh flooring throughout. So not a major overhaul, uh, but basically just taking something that’s five to 10 years out of date and getting it, uh, more current, more or less.
Not doing like high-end granted or really high end appliances, just taking something that’s a little bit old and worn out and, and make it a much more livable for people. So we see this nice $250 Delta in the rents, and that lets us know that this is definitely something worth. And as we dive a little bit deeper, we also find out that the current owner is not taking full advantage of all the other opportunities available to them, uh, to provide value to the tenants, uh, specifically, uh, other than under the other income section here, we see that this owner is not allowing pets there.
Uh, parking is, is undercharged for, and, uh, there’s no bill back for, uh, utilities. [00:04:00] Technically billing back for utilities doesn’t really provide additional value, but it’s something that’s very prevalent in our market. And the fact that this owner is not currently doing it, uh, it means that that is an opportunity for us.
Um, but allowing pets is a huge value add because there’s tons of people who love pets and when they go and they search for an apartment building to live in, uh, their options are very limited because not a lot of owners want to have pets in the buildings. Uh, but we think that that’s a great option that I have for people.
Um, myself and Anthony both love pets. We have pets. So we’re big supporters of that. So right here, we’ve got our current other income items on a monthly basis. And then we’ve got the annualized income from those sources here. And then if we go down to what we’re planning on in the future with this project, we can see that we are going to start to charge $25 per unit per month for YouTube.
Which is honestly pretty low considering what a lot of the rest of the market does charge. Uh, we’re going to charge a more appropriate amount for the parking and this all is, uh, implying that we’ve, we’ve made the building better. Right. So where are you going to introduce these charges? Once [00:05:00] we’ve improved the property and then with the pending.
Uh, we’ll start allowing people to bring pets in. So over the course of the next two to three years, as a units, organically turnover and new people come in, we’re assuming that, you know, 15 to 20% of those people might have some pets and a laundry. We’re just kind of keeping the same. So we’re going to take our annualized other income from 9,360 up to $22,000.
And he might be looking at that and the rent increase in saying, okay, you’re taking your income from, you know, three, 300,000. From roughly 333,000 up to roughly 436,000 over the course of, probably about two years for 30 unit building. Um, that’s great. So your income’s increasing your expenses will probably go up a little bit, like what’s so exciting about that.
The exciting part is the value of the property and how that changes. So we’re going to dive into that in a second here, but first we’ve got to take a quick look at how much capital it’s actually going to take to execute this project. [00:06:00] So down here, we’ve got our, um, improvement budget, which like I said before is $7,500 per unit.
So $225,000. And then when you add in the down payment and closing costs and all that stuff, we’re going to need about 1.3 million, uh, to execute this, uh, this deal. So now let’s dive into what actually happens as we make these improvements to the value of the property. Now, remember we bought this thing for 3.45.
So in year one, uh, we don’t have a rents increased yet. Our other income is still about the same and our operating expenses are about $160,000. So our NOI is $173,000. Now the NOI is what is going to drive the value of the property as that number increases, we’re going to apply the cap rate, which is a multiplier used for the valuation.
To the NOI and that’s what drives the value of the property. So as opposed to looking at comps, like you would in a smaller market, we’re going to apply a market cap rate to the NOI, and that’s going to drive the [00:07:00] value. And like I said, much more black and white and much more quantitative than the smaller market.
Um, and that’s like I said, what really drew me into this one? And you’ll see why in a second here, because as the Senoia increases, the value is going to increase substantially more than the amount of money we needed to spend to make these improvements. So by year two, uh, we can say that we’ve maybe made it through about half of our projects.
Now we’re taking a slow roll with this trying to keep occupancy and collections high so we can keep getting cashflow the entire time, but we can see by the halfway point, we’ve already taken it from 3.4 million up to about $4.3 million. Now, remember we’re only spending about $225,000 on improving. So right here.
I mean, we’ve already got our money back in valuation. We’re not even done yet. By the time we get to our target rental income and target other income, we can say our NOI has gone from 173,000 to 260,000, which is almost a hundred thousand [00:08:00] dollars of increase there. When we apply the cap rate to that, our value goes from 3.45 million, which we bought it for up to 5.2.
That means we added 1.7, $6 million in value by spending $225,000 on improvements. And now, obviously there was more money that went into this 1.3 million that was down payment and closing costs and all of that stuff. Uh, but by and large, by spending $225,000 in improvements, we made $1.7 million in newly created equity.
And that is. One of the best parts about investing in multi-family real estate. In my opinion is the, just really black and white and quantitative way of being able to forecast the value of the property. Um, That’s what, that’s what got me hooked initially. And I think that’s what really gets the light bulb to come on for people.
When they’re trying to wrap their heads around this business model is show me the math. How does it work? And once you wrap your head around how the valuation works and how [00:09:00] the forced appreciation value add model works, I think everything else just starts to click. So hopefully this provided value for you guys.
If you have any other questions, don’t hesitate to reach out multifamily investing made simple as the podcast, check it out. If you’re into this kind of stuff, and we’ll see you guys in the next.