Higher priced capital makes renovating and flipping multifamily projects more complex, but value-add transactions are still thriving in some markets.  

Flipping any kind of real estate is a lot easier when the cost of capital is low, a condition that began deteriorating in early 2022 when the Federal Reserve began a long upward hike of the federal funds rate. Data from the National Multifamily Housing Council published in July shows continuing tight market conditions, with a slight uptick in sales volume. Equity financing is down while debt financing is up.   

Geography is also playing a role. “Rent growth remains low in the South and West amidst a historic overhang of new supply, even though strong demand has kept absorptions high and occupancy stable,” said NMHC’s Chief Economist and Senior Director of Research, Chris Bruen.   

“Tighter apartment conditions persist in the more supply-constrained Northeast and Midwest,” he added. “While high levels of political and economic uncertainty have kept some equity capital on the sidelines, survey respondents did report an uptick in transaction volume for the second consecutive quarter.”  

The Current Situation  

Supply levels, the cost of capital and finance options are all playing a role in the current situation of value-add transactions in the multifamily housing industry.  The market is responding and keeping hope alive.   

“We’re seeing modest market adjustments that are helping keep these deals in play,” said Chris Pilato, Chief Development and Construction Officer for CAPREIT, an owner-operator based in Maryland. “This includes lower pricing on classic value-add communities, as well as increased participation from alternative debt providers stepping in to fill financing gaps. These shifts are contributing to renewed activity and creating more opportunities in the sector.”  

Many value-add renovations in the past focused on countertop and flooring upgrades to enable rent growth. The new thinking leans into plumbing, HVAC and electrical fixes. “As a result of the softening we are seeing in market rents due to supply influxes, we have had to reinvent how we look at value-add,” said Brennen Degner, CEO of Platte Canyon Capital. “Our strategy today revolves around what we think these older buildings need.”   

Platte Canyon is based in Colorado and specializes in value-add deals. Evaluating vintage properties these days is focused more on acquiring the property at the right price point to maximize net operating income.   

“Today, we see an opportunity to buy deals right without needing that incremental upside to make them work,” said Degner. “We are focused on creating value through buying at a basis that supports the additional costs for the infrastructure items that have been challenging to fully factor into CapEx budgets.”   

The age of the value-add targets is also playing a bigger role. “We’re now placing greater emphasis on older vintage properties, which often offer more upside potential,” said Pilato, “Additionally, we’re incorporating increased contingency planning into our underwriting to account for rising construction costs, potential tariffs and overall market volatility.”   

Marquette Companies has two offices in Illinois and a third in Houston. Their portfolio includes a heavy concentration in the Midwest, where there is fertile ground for value-add deals.   

“Current market conditions have had us looking even more closely at value-add, especially in the Midwest where fundamentals like high-demand, low supply of new construction, job growth and affordability are making these kinds of opportunities in this region particularly attractive,” said Trevor Ryan, President of Marquette.   

“We recently sold The Haven at Ann Arbor in Ann Arbor, Mich., after undertaking a $13 million renovation and leaving the property at 95% occupied at the time of sale,” he said. “The deal exceeded all target return metrics for our investors.”   

Sources of Capital

To bring in new money, developers and owners are employing alternative methods to make value-add projects pencil out and attract funding. “Value-add multifamily real estate remains a very sought-after asset class across the board,” said Ryan. “Our Marquette SE Fund 25, which we just launched and is focused on value-add, has been met with strong investor interest and early participation. While we have a solid reputation and track record in value-add, this level of interest highlights the enduring appeal.”   

Fairfield, a developer, owner and operator that is majority-owned by the California State Teachers’ Retirement System, made headlines in February by closing a $1.47 billion fund focused on acquiring value-add properties in 30 markets. About $350 million of the funding came in as co-investment equity.   

“There remains a liquid market for construction financing with alternative lenders including debt funds continuing to grab market share away from typical banks with more flexible terms, a higher appetite for risk and significant institutional capital flows into the private credit sector,” said Jason Schwartz, Managing Principal and co-head of Equity for Blue Vista, a real estate investment firm based in Chicago.   

There are other alternatives in addition to creating or tapping a debt-based instrument. “In the middle-market multifamily space, we’re seeing an increased reliance on cash acquisitions and a resurgence of seller financing,” said Paul Waterloo, a Managing Partner with Interra Realty, a brokerage firm based in Chicago. “Local and regional banks continue to offer financing, typically favoring experienced local sponsors with a track record of successful value-add projects.”   

Magic Numbers   

The Federal Reserve continues to move cautiously in making any adjustments to the federal funds rate.  While billions in capital wait on the sidelines, forecasters imagine numbers that could change the game or at least keep properties in play.    

“With interest rates remaining elevated compared to three to four years ago, it’s more important than ever to make sure your cost of debt for a given deal aligns with its initial yield-on-cost and projected NOI growth through the hold period,” said Ryan. “While the spread between going-in capitalization rates and interest rates is as narrow as it’s ever been, debt is still meaningfully cheaper than equity, so the use of leverage is still a strategy we recommend.”   

As of the last meeting, the Fed rate was cut by 250 basis points, which puts the prime rate around 7.25%. Owners, investors and commercial real estate brokers are keeping a keen eye on the numbers and forecasting what would significantly move the value-add needle.   

“An interest rate around 5% would increase demand for value-add properties,” said Waterloo “Many current sales are projected to stabilize at cap rates exceeding 7%, offering a healthy 200 basis point spread – though increased competition could eventually narrow this gap through increased pricing.”   

Value-add possibilities are also showing up in situations where the property’s original owner may be looking for an easy cash out of the property. “Many of these properties are still owned by legacy operators or families who have made minimal reinvestment over the years,” said Pilato. “That creates a real opportunity to unlock value through targeted renovations and operational improvements.”   

The changing supply level of new inventory is also factoring into the buying, fixing and selling of assets. “With new multifamily construction slowing down significantly, the supply-demand fundamentals are becoming more favorable,” said Pilato. “Well-located, upgraded vintage assets are positioned to benefit from that imbalance.”   

Figuring out the right terms to float a value-add deal requires special consideration for the complexities during and after the renovation, which can include variable rate loans.   

“Real estate investors should consider the anticipated hold periods for individual assets and execute a mix of fixed rate financing and floating rate financing with interest rate swaps and caps,” said Schwartz. “Investors that continue to look at acquisitions with fixed rate financing should go ahead and lock their interest rate whenever it works for a given deal. In the case of floating rate financing, swaps and caps protect against a surprise rise in interest rates, and they can be tailored to the investor’s hold period, investment budget and risk tolerance.”    

Real Estate Closing Thoughts    

The concept of value-add can be stretched to other branches of the multifamily housing tree. “We are actively involved in both buying and selling residential properties, primarily conventional multifamily, build-to-rent and student housing,” said Schwartz.   

“We currently have five new projects under development across the country with deliveries expected within the next 12-24 months,” he added. “We also continue to pursue residential value-add acquisitions, where properties can be purchased below replacement cost.”  

Even though high costs of capital and sluggish rent growth have dinged the allure of value-add, there are still deals getting done. “The market is adjusting, not stalling,” said Waterloo. “There is still robust buyer interest compared to the limited supply of well-located multifamily properties ideal for value-add strategies in Chicagoland.”   

“Value-add is always going to have a place in the multifamily market,” said Degner. “As supply recalibrates closer to an equilibrium you will see re-filtering of [residents] back through the traditional A, B, C asset quality segments. At this moment in time, traditional value-add of going in and making a unit slightly nicer to get a pop in rent is difficult, but there is also value to be added in simply buying right and improving the health of a property’s balance sheet, which we are seeing plenty of opportunity with currently.”   

Scott Sowers is a freelance writer.