Renovations may be common in today’s multifamily industry, but that doesn‘t mean they’re easy to pull off.
With the development of new multifamily communities soaring in markets across the country, many apartment owners are finding that renovations are necessary to remain competitive. Others are renovating to get ahead of the competition. However, apartment executives are quick to point out that numerous pitfalls await owner–operators who rush headlong into the process without studiously determining the upgrades that will truly allow them to push rents and without carefully planning the on-site construction process.
“ ‘If you build it, they will come’ doesn’t always apply in the multifamily world, and over-renovating is a common and costly mistake,” says Don Stocks, vice president of residential operations for Bethesda, Md.–based ROSS Management Services. “If prospects aren’t willing to pay higher rents to justify the costs, you can renovate all day long and watch your cash yields diminish. So you have to identify the upgrades that will actually drive rents. You also have to organize the renovations so that you limit unit downtime and maximize your exposure to the peak leasing season.”
Owners have been aggressively pursuing value-add acquisition opportunities in recent years, and renovations figure to remain a prominent feature of the multifamily landscape for a while.
Resident demand for apartments is set to soar over the next dozen years, according to a 2017 study commissioned by the National Multifamily Housing Council and the National Apartment Association. To meet the demand, 4.6 million new units will need to be built by 2030, the study says. The upgrading of existing communities will play an important role. More than half of the existing apartment stock was built before 1980, meaning 11.7 million units could need upgrading over the next 12 years, according to the study.
With that in mind, below are some of the most important steps owners must take to ensure a successful renovation effort, according to your peers in the industry.
Determine the Right Scope
Step one in any successful renovation effort is to accurately determine the renovations that will allow a community to push rents and achieve the returns the owners and investors want.
“Under- or over-renovating is certainly a trap that owner–operators can fall into,” says Jay Madary, president and CEO of Oak Brook, Ill.–based JVM Realty Corp. “If you purchase a property and spend, say, $2,500 per unit on new flooring and countertops, but you have outdated cabinets and appliances that aren’t attractive, you may not see the return on that investment,” he says. “Conversely, if you go in and just gut the whole unit down to the studs and rebuild everything, you may still not be able to achieve the rents that would justify that renovation.”
The key to pinpointing the renovation “sweet spot” is to perform an exhaustive amount of due diligence, experts say. Owners should study the success of other recent renovations in the submarket and dig into the overall performance of their competitive set to see which amenities and unit features are pushing rents. Comb through data like median incomes to see if residents can pay the targeted rent growth. In short, owners should examine and factor in every conceivable bit of market intelligence and data they can find.
It’s vital to not only consider a submarket’s current condition but also to get a handle on its long-term trends to see whether it could sustain rent growth, says Chris Pilato, vice president of construction and development for Rockville, Md.–based CAPREIT.
“Before we embark on renovating a community, we’re very careful to ask: Is the surrounding submarket one that’s on the move, that’s going to experience more demand?” Pilato says. “Is it stable? Or is it going in the wrong direction? Are we going to have residents or is this population shrinking? Is it going to be harder for us to rent these units even if we can get the ROI?”
For owners who don’t operate their communities, a third-party management company can be an invaluable ally during the planning and consideration of a renovation, Stocks says. “A third-party manager who’s experienced in that market can tell an owner, ‘This is really what this product needs to do, because we’ve been looking at it—either through our own management or as part of our competitive set for years,’ ” he says.
Another factor to determine is what percentage of a community’s units will be renovated. That answer, according to Pilato, depends largely on how long an owner is planning to hold the property. The shorter the intended hold time, the smaller the number of renovated units, Pilato says.
“If this is only going to be a three- to five-year hold for us, we want to do enough to show that we moved rents, but, at the same time, we want to leave something for the next owner to come in and renovate and be able to maximize their financial upside,” Pilato says.
Finally, before deciding to take the renovation plunge, it’s imperative that an owner has a full and complete understanding of any environmental problems that may have to be addressed, Stocks adds.
“Older product often has the risk of potential asbestos-containing material in drywall, floor tile, and tile mastic,” he says. “Review the phase one environmental reports to understand the risk, as well as potential costs. Abatement costs can be extremely prohibitive and, in many cases, have a drastic impact on the scope of renovations.”
Tightly Organize the On-site Renovation Process
Once the scope of a renovation has been determined, the owner–operator needs to ensure that the renovations are carried out in an efficient and orderly manner.
“You have to have a process and a project manager in place to ensure that you’re ordering materials in advance, managing occupancies and vacancies appropriately, and making sure that contractors get in and get out in a timely fashion,” Madary says.
For starters, it’s critical from an ROI perspective that units undergoing renovation not be off the market too long. “Is the unit going to be down for two weeks, or is it going to be down for six weeks?” Madary asks. “The answer can make all the difference in maximizing your return on that project.”
JVM upgrades a community’s common areas and amenities as well as its model units before addressing the residents’ units. That way, all tenants benefit from the renovation effort early on, and seeing the upgraded models helps build interest among current residents in leasing a renovated unit, according to Madary.
Throughout the whole process, operators must keep residents firmly in the loop about the timing of the renovation as well as any and all possible disruptions, Madary adds. Poor communication with renters during this time can severely strain resident relations, he says.
Consider Timing and Be Flexible
When renovating, it’s important to, as much as possible, time the process so that the units are brought back on line during seasons of high demand, Stocks notes.
“In our primary market here in the [Washington] D.C. metro area, if you’ve done a renovation and the unit’s coming back to you in late November, most likely you’re going to need concessions just to get it rented, because it’s out of peak leasing season, and you don’t want to sit on this product for months,” he says. “So you have to understand the demand idiosyncrasies of each market so that you can time your renovation and the delivery of the product to hit the peak leasing time frame and maximize the rents and the returns.”
And owners shouldn’t be afraid to be flexible once the renovation process gets under way. If, despite the due diligence performed at the outset, the completed units aren’t garnering the rent premiums originally targeted because of changing marketing conditions, the owner “shouldn’t be afraid to revise its scope a little bit lower,” Pilato says. “You’re still making the property nicer than it was before. On the other hand, if you’re getting higher rents than anticipated, go for it—be willing to do more to the units.”