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What is value add real estate and why is it such a popular investment strategy in 2021?

After a year when everything changed, the state of real estate continues to be rather uncertain. Although everyone expected the entire market to drop, both Welsh and British real estate have remained surprisingly resilient, and certain regions have even experienced growth. In June 2021, the average price of a UK home had risen to £336,000, while Wales experienced the largest annual house price growth out of all UK nations. Compared to the national average, homes in Wales are much more affordable, which is precisely why the market continues to thrive. But just because the outlook for real estate is generally positive, that doesn’t mean that investment strategies have stayed the same. On the contrary, the pandemic and all its implications has shaken up the market, putting some investors at risk while offering surprising opportunities to others. This is the main source of investor uncertainty these days, which is why it’s important to understand what works and when.

The presence of value add real estate on the list of successful real estate investment strategies in 2021 might seem surprising to some, this having previously been just a niche. However, as proven by many success stories in the UK and Europe in general, value add real estate can yield excellent results.

According to recent data, the prospect of economies reopening increased investors’ appetite for risk, which is why, in June 2021, there was a significant increase in value-add investment strategies. The trend isn’t new. Even when the pandemic was in full force, many investors favoured value add investments and made billions in sales – one example being that of Aroundtown (where the real estate expert Yakir Gabay is member of the advisory board and has 10% interest), made over €4billion from selling properties on the European market. 

But what exactly is value add real estate, and why do some investors resort to it in uncertain economic times?

How does value add real estate work?

First of all, it should be pointed out that investing in real estate shares many similarities to investing in stocks and bonds. Depending on the type of property you decide to invest in and its location, the investment can carry a higher or lower level of risk, and the returns will vary as such. Depending on the property’s characteristics, its management, and the state of the economy, it will be harder or easier to sell. For example, the general investor sentiment is that housing communities built for workers are safer, whereas luxury apartments and vacation houses are more volatile because they’re subject to the whims of the economy. These principles apply to residential real estate, but also to commercial real estate, where investments fall into three categories: 

  • Core investments: these refer to safe, well-developed buildings in class A markets that do not require any improvements and that are easy to rent immediately after buying. These properties may not necessarily provide the highest yield, but they usually provide the expected yield, making them the safest investments. They are stable, maintain their value over long periods of time, and they are in resilient sectors that aren’t easily affected by economic crises.  
  • Value add investments: these refer to commercial investments in markets and properties that have potential but that need improvements in order to increase their cash flow. For example, the investor might have to remodel or repurpose the property or change the management, since these are usually the reason why the property performed below its potential, to begin with. Then, once all the improvements are made, the investor can lease the properties at a higher cost, which provides significant returns. Unlike core investments, value add investments carry a higher level of risk because if the property isn’t improved properly, then it will be harder to find tenants or rent the property at the expected cost. In general, value add investments are seen as the perfect balance between risk and reward.  
  • Opportunistic investments: these are similar to value add investments, but carry a much higher level of risk because the properties require serious improvements both in terms of structure and management before they can be leased at full price. Quite often, these properties are in such bad condition or are so affected by the economy that they do not have any tenants at the time of the investment. If rehabilitation works according to plan and the investor has a lot of experience with such projects, then opportunistic investments can generate great profit. That being said, the risk is very high, and success is never guaranteed, which is why even experienced investors only use this strategy sparingly.    

Why are value add real estate investments on the rise?

Choosing value add real estate investments in 2021 might seem like a surprising strategy considering that the economy is still uncertain, but it’s precisely this uncertainty that makes them smart opportunities for savvy investors. Due to digital transformation and COVID-19 measures, many commercial properties were left with low cash flows and struggling balance sheets. Markets that had previously been profitable, such as hospitality and retail, experienced many challenges in the past year and many businesses even had to close down.

With the value add strategy, investors can acquire properties at lower costs, and then restructure and convert them to reflect the new needs of the market. For example, the strategy employed by AroundTown in Germany involved the conversion of hotels that no longer had clients to residential properties such as micro-apartments, student housing, or assisted living. Not only did this provide great returns for the investing firm, but also answered the market’s need for affordable properties, which shows that value add investments can be a win-win situation. 

In Wales and the UK, data shows that distressed hospitality venues are the primary target of value add investments. At the same time, to manage risk, investors combine the value add strategy with core investments.