An investment property is “Upside Down” when the owner owes more than the property is worth, which is something that many residential owners understand at the moment. This may be bad for the owners, but for investors these points of weakness in the property can sometimes be improved, adding value and rewards.
The search for “Value Add” properties with Upside is what drives certain commercial property investors to ferret out tarnished, tainted or downright tawdry properties and become rehabilitation or repositioning experts. When you turn around properties with significant challenges, you can see annual returns of 30% and much more for your efforts.
Go looking for trouble
That’s right: You are looking for properties with problems. Just make sure they are ones you can successfully address.
If you find a property with a vacancy rate of 15% in a market where the average is 5%. You may have some Upside available to you there, but it depends on whether you can actually bring the vacancy rate down to the market rate once you are the owner. If you do, you are assured a major return boost for your efforts.
Upside is a Three Step Process
1) Find the Problem
It isn’t that hard to find problems in an ugly old strip mall or apartment complex with a bad reputation and a very motivated seller. Finding the problem is step one. This is the easy part.
2) Fix the Problem
The 64 thousand dollar question is how can you fix it? And it may be worth much more than $65K to you.
Here is where you can lean heavily on your local team—especially your property manager. Your property manager will know the neighborhood, the market rents and standard amenities for the area. They may know this building well. They may have even managed it in the past. You can sit down with them even before you put in a letter of intent, and brainstorm an action plan for addressing this property’s problems and realizing the Upside.
Caution: Keep in mind that you are betting that you can fix a problem that the seller couldn’t. Don’t get cocky. Make sure that you and your property manager can see a step-by-step solution built on strategies that the seller didn’t use or didn’t execute well.
3) Harvest the Upside
Remember the multiplier effect of the capitalization rate on any extra income you can retain at the property. The math is pretty simple.
Increase in Income / CAP Rate = Increase in Value
When you produce just $100 per month in extra profit, you add a full $20,000 to the value of the property at a 6% CAP Rate.
$1200 (per year) / 6% CAP Rate (0.06) = $20,000 in increased Value
It all starts with a simple question
The shortcut to finding extra profits in your next deal starts with a simple question to the listing broker:
“What’s the Upside in this deal?”
Here’s to safe and profitable investing.