Q&A with Kevin Dillon and Jason Krug: Value-Add Acquisitions in the Midwest

April 27, 2021

Q&A with Kevin Dillon and Jason Krug: Value-Add Acquisitions in the Midwest

April 27, 2021

As widespread vaccine roll outs gain ground and signs of a return to normalcy emerge, the multifamily investment sales market is picking up steam and nowhere is that more apparent than in the Midwest. Detroit Investment Sales, part of Berkadia Midwest, which works with clients across the Midwest, closed more than $285 million across 11 transactions in the first quarter alone.

We sat down with Senior Managing Directors Kevin Dillon and Jason Krug from Berkadia Detroit Investment Sales to discuss the state of the multifamily market in the Midwest, what’s driving momentum and why value-add opportunities are attracting particular interest from investors.

Q: How would you describe the current state of the Midwest multifamily market?

Jason Krug: Demand was strong heading into the pandemic. The marketplace paused in the Midwest with limited transactions through mid-last year. However, very low interest rates and the resiliency of multifamily property performance in Michigan and Ohio had investors aggressively pursuing the market with a focus on value-add opportunities. Today, we are experiencing a record high demand for opportunities with a scarcity of available assets. An uptick in the treasuries has caused some pause, but there is still far more demand that has not yet been satisfied.

Q: Are investors looking for specific asset types? Or does it just depend on the deal?

Kevin Dillon: Investors are looking at all types of properties, classes and markets. We’re seeing all different types of investors—from highly sophisticated capital such as Real Estate Funds and Institutions, to local owner/operators, to family offices—interested in the Midwest, and they’re especially eager for more cashflow and value-add type of properties. Buyers are moving capital from all parts of the country to the Midwest. With a proven concept, investors today are able to get creative with their value-add programs allowing for more aggressive sale prices. Essentially, it is a seller’s market.

Q: How are investors evaluating potential value add deals?

JK: Most investors try to be basis conscious in looking at value-add opportunities. They pay attention to replacement cost and new construction figures to make sure they are not going to be all-in on an existing opportunity for more than it would cost to build new.

When looking at a value-add opportunity, investors typically consider one of three tiers of improvement programs: a complete renovation to individual apartments as well as the common areas, which could cost as much as $15,000 to $20,000 per unit; a midgrade improvement may include a combination of unit interior and property/amenity, which could cost between $8,000 to $12,000 per unit; or a more modest approach, which might cost between $3,000 and $6,000. The upgrade package is based on the accretive value of the rent premium.

The average renovation will achieve a minimum return on investment of 18 percent, but often investors are able to surpass 18 percent and achieve something closer 25 percent ROI. We have seen light renovations successful with as little as $50 a month in premiums. We have also seen heavy value-add opportunities where sellers are getting $400 to $500 or even higher in monthly premiums. The average would likely be around $150 to $200 a month in renovation premiums.

Q: What is your role in working with clients and investors on identifying the right value-add opportunity?

KD: An investor’s ROI depends on a number of factors outside of just a renovation program, which is where our expertise comes in. Investors need to have a clear understanding of the local rental market, comparable properties, regional and submarket economic factors and other indicators that will impact the long-term success of their investment.

We work with sellers to provide this robust overview of an opportunity. With sellers, we run a process to maximize value of a listing by digging into the market data and trends, highlighting existing value-add components as well as uncovering additional value-add opportunities and ultimately giving a full picture of the long-term value to prospective investors.

Recently, we sold three contiguous properties—626 units—in Southgate, Michigan. The properties were sold by the families of the original developers and had been very well maintained. The new investor will focus on the unit interiors and amenities without the added cost for roofs, HVAC, windows and parking lots, which remained in excellent condition. The new investor is targeting value-add improvements of approximately $12,000 per unit with the expectation of achieving $250 to $350 in rent premium equating to 25 to 35 percent return.

Senior Managing Director Kevin Dillon and Managing Director Jason Krug