Buildings age and neighborhoods change. For most income-producing real estate, this is a gradual process. Over time, systems wear out, buildings are not kept up, newer buildings siphon off the best tenants, and financial performance declines. Poor management can bring in the wrong type of tenant, accelerating the process. Occasionally, the decline in a particular property’s value and performance is not mirrored by what is occurring in the market or in the area around it. This can result in tired or poorly performing properties in stable or improving neighborhoods. This is the ideal opportunity to look for.

Repositioning troubled properties to increase their value has been a time-honored investment strategy.

When renovating a property to add value, I am primarily looking at two things: How can I increase the income and how can I create operating efficiencies to increase the Net Operating Income (NOI). These are not the same. Although NOI is the driver for CAP rate determination of value, many people still look at the income multipliers and other metrics. I’ve found that working on both is of equal importance to maximize value – whether for sale or refinance.

Creating the Plan

Before the first piece of trim is removed, one must analyze what is the best use of our available cash. The position of the rehabilitated asset in the market must be defined. What are the likely demographics of future renters? What will they desire? What will they require? What can you give them that they can’t find in the competition? What can they afford to pay?

When evaluating a property, a physical examination of the condition of the overall asset, both visible and invisible is a must. There will always be some costs to repair that will not add rental value (such as replacing a roof) but which are necessary to do. Whenever we encounter these situations, we try to determine how the item could add value, and whether the additional cost would be justified. For example, our firm purchased one building where the plumbing was at the end of its useful life and needed to be replaced. When we replaced it, we created a direct hot water and cold water feed to each unit. This not only allowed for submetering capabilities (thereby removing the water bill as one of our expenses) but was also great when repairs were needed, as we had individual shut off valves to each unit.

There is always a finite amount of money to work with. It is crucial to quantify the scope of work, and while this is difficult, it is not impossible. Always have a contingency factor in your budget for unexpected surprises or cost overruns. I recommend at least 15%. There is nothing worse than running out of money before your project is complete.

Implementing the Plan

Regardless of the level of occupancy and the overall caliber of the existing residents, the property is underperforming or you would not be attempting this upgrade. The actions of the prior owner or manager have been sending a strong message to those who live at the property who have developed bad habits– whether this means paying rent late, intimidating other residents or neglecting the property. Your immediate task is to establish order. This is best done by being present on site as much as possible and by establishing policies and procedures that will let the residents know what is and what is no longer acceptable.

Repositioning an occupied property is not easy. You can’t just vacate the building and start renovating, especially in a city like Oakland or Berkeley, which have eviction restrictions. However, even if you had no restrictions, carrying costs on a vacant property could eat up most or all of your potential profits, so it is usually best to work with occupied buildings and improve apartments upon turnover and over time.

Perform a thorough unit by unit inspection as soon as possible. Note any habitability issues and fix them. This is not only your responsibility but will be a tenant’s defense when they don’t pay you rent. Look for lease violations. Are they keeping pets when they are not supposed to? It’s time to enforce the rules. You might start sending rent invoices as well, at least temporarily, so everyone knows what is owed and what is expected of them.

Show Respect for the Property

It is now time to show a new level of respect for the property. A sudden clean up does wonders for laying the groundwork and regaining control. If the property has become unkempt – or some tenants keep destroying it – a little paint, a little landscaping, and some good old elbow grease will go a long way. People tend to mirror their environment. If it appears that the owner or management doesn’t care, they won’t care.

At first, you might wonder why you’re even bothering to do this. Many times, the next day all your work looks like it’s been for naught. There’s garbage or cigarette butts on the ground again and sometimes even new graffiti on the walls. But press on. Soon your efforts will begin to take hold. You’ll start getting positive feedback from many of the good tenants.

Other first-impression cleanup items include towing any abandoned or non-working cars, making sure all common area doors close and lock properly, and keeping the place clean. If you do not change things quickly and strongly, you will not regain control.

When you start cleaning up the property, you need to be very public with your tenants. You need to get the word out – graphically – that things have changed. Strong communication is important – but it’s time for a little drama. Put on a show. Drop a great big debris box on the property and invite them to fill it. Post 3 Day and eviction notices clearly where they can be seen. Get the police to do a sweep through the property, if needed. This is the time to set the tone – everyone is watching.

Rekey common areas. If the building has more than a few units, I recommend an electronic key (key fob, key card) that is programmed on a computer and can be deleted and reprogrammed. Physical keys can be easily copied and you want to keep the problems out. After going through the process of re-keying of common area gates and doors every time you evict someone, you will see why electronic keys are a bargain in the long run.

If you can afford it, place cameras at critical areas on the property. Technology has made quality video surveillance relatively affordable. If you are taking over a property that has had a history of drug dealing, loitering, or other nuisance activity, just the presence of video will reduce the problem.

How’s the lighting in the evening? People hanging out in front? A little physical modification can do wonders. We had one property where people were doing drug deals in the evening in front of the property. We installed a sprinkler system that ‘accidentally’ over sprayed onto the sidewalk. It didn’t take long for them to move to another location when the sprinklers came on ‘randomly’ at night. People don’t like doing drug deals with sprinklers spraying on them.

Focus on the Common Areas

The entire repositioning process is a marketing process. You are making physical changes to a property and adopting policies and procedures that will attract the resident profile you prepared from your original market analysis.

You must wait until the exterior work is done before you can really market the property. It takes time for a property to change its reputation in the community. The easiest way to make this change is for it to look different to the outside world. Until that happens, none of your claims of improvement and change will be listened to. You wouldn’t show a dirty apartment to a prospect and tell them it will be clean when they move in and expect to receive top dollar. Similarly, you cannot officially declare your building changed and expect the world to believe it until the outside states that it is.

The sense of arrival is critical for creating good first impression. You need to think through what someone will see from the moment they drive up until they meet with you, whether at the building entrance, a leasing office, or at the vacant apartment you have for lease. Site improvements like lighting, gates, lobby areas (in interior hallway buildings), pavement accents, signage, and landscape upgrades can produce a major shift in presentation and perception of a building.

Focus on creating memorable social spaces. Create some sort of ‘wow’ factor at your property, something that makes it unique. This could be a rooftop deck with a view, or a nice outdoor BBQ area – ideally something they won’t find at a competing property and will allow you to charge a premium rent for the neighborhood.

Only then, focus on the apartments

My philosophy is – the common area gets them in but the apartment interior is what makes them stay. Once you’ve got your common area planned, then move to the apartments. In the apartments, we first focus on intangibles. How do we make the unit feel more spacious? How can we make the unit feel more light? All things being equal, people will pay more for an apartment that is bigger (or feels bigger) than one that is smaller. All things being equal, people will pay more for an apartment that is full of light, than one that is dark. Likewise, one that feels newer and of higher quality gets a premium also.

The first areas of focus are often the kitchen and bathrooms. Utility areas and adequacy of storage are next. The quality of finishes in the remaining areas then form the third area of focus.

In the kitchens, appliances and countertop surfaces are the two areas that most date a property, and also reflect the greatest wear. Replacing an old laminate top with a new granite or faux granite top and updating the appliances makes a huge difference. Many times cabinets can be refinished or refaced without having to be totally replaced.

In the bathrooms, introduce current accessories such as a new vanity top and updated faucet; supplemental shelving (an area often neglected), decorative vanity light fixtures, and a framed mirror. Paint and updated lights make a huge difference in the feeling of the bathroom.

After looking at the kitchens and bathrooms, flooring, door style, lighting, hardware, and interior trim all contribute to the appeal of the apartment.

Then add value with services and policies

While there will be costs to physically change the building in your pursuit of higher NOI, there are a number of service related items that will also generate increased income or allow you to ask higher rents. These might include offering common area WiFi in the building, creating storage areas that can be rented, going ‘a la carte’ on the items typically included with the apartment (such as parking) and allowing pets for an additional monthly fee. Ultimately, your target market will determine which additional services can be profitably provided.

Even with a system for upgrading properties, each building presents its own unique set of challenges. Your financial success as an owner depends on how well you, or your manager, can handle the challenges, gain control of a property, and then transform it. Although there will be many difficulties, repositioning a property is a very rewarding endeavor which not only profits you but enhances the neighborhood in which the property is located.