New Series Kickoff: Executing Your Business Plan

From business plan creation through completion

We are making great progress in our journey of understanding how to personally invest in real estate. We have covered four main subject areas so far:

1. Introduction to Real Estate Investing

2. Investment Fundamentals

3. The Acquisition Process

4. Owning and Managing Real Estate

See the end of this newsletter for the link to all 20+ newsletters so far.

Today we are kicking off a new series: Executing Your Business Plan. 

Whereas owning and managing real estate anchors you in the tasks with which every investor will be faced, executing your business plan leads you down a proactive approach to adding value to your investment and making you more money!

This is one of my favorite aspects of owning investment properties. The ability to take action to improve performance and make you more money.

Some like to say that most of the money is made in the buy (aka the acquisition). 

I agree to a certain extent. 

You can never change your original cost basis or location. These two factors play a huge role in how the property will perform.

But…they are not everything.

Your ability to identify and execute a business plan will play a material role in how well your property will perform over the months and years of your ownership.

In this series we will cover:

• Ways to add value to your property.

• How to create a property business plan.

• Construction.

• Leasing.

• Investor and lender constraints and opportunities.

Today we will start with an overview of ways to add value to your property.

Let’s dig in.

Definition: Adding Value

The terms “adding value” and “value add” are thrown around a lot in real estate investing. They are very similar terms that mean different things.

Adding value is the act of doing something to increase the value of your property. Usually you have to spend some money to create the value, but this is not always the case. Let’s list some examples of adding value:

• Cosmetic improvements

  • Exterior: this could be as simple as painting your property or cleaning up the landscaping. Anything that makes the property look better.

  • Interior: same concept for the inside of the property. Think paint and carpet.

• Functional improvements: 

  • Interior: we are staying inside the building, but we are improving the way the tenant can functionally use the property. Examples could include: improved lighting, an additional room, or new HVAC.

  • Exterior: same concept on the outside. Examples could include: expanded driveway or a new tenant signage program.

• Leasing: sometimes the biggest value creation will be through leasing. This could be through renewing and/or restructuring the leases with existing and/or leasing to new tenants. As we discussed in Cap Rates: The Simple Math of Real Estate Investing, much of real estate value is determined by the NOI. The biggest driver to NOI is usually the rent the tenants are paying. 

Improving the interior and/or exterior of a property usually go hand in hand with increasing the rents and driving up the property value.

These are examples of “adding value”. Let’s compare this to “value add”.

Definition: Value Add

Value add is most commonly used as an investment category signifying the amount of risk associated with a real estate investment. We discussed this in The Risk-Return Spectrum: Choosing Your Real Estate Investment Strategy. A quick summary:

Low Risk/Low Return ←――――――――――――→ High Risk/High Return

Core/Turnkey → Light Rehab → Value Add → Development

1. Core/Turnkey: low risk, low return. You buy a property that is well leased and maintained. There is minimal work to do.

2. Light Rehab: medium risk, medium return. There is some work to do, but it is mainly cosmetic (paint, carpet, clean up). If you do the work, you can increase the rent and value of the property.

3. Value Add: high risk, high return. There is a lot of work to do. The property might even be vacant. You will be repositioning it and taking on a lot of risk for superior returns. You will either find a tenant once the work is complete or sell it (fix and flip).

4. Development: highest risk, highest return. You build something from scratch.

So when someone says this is a “value add” deal, they are usually referring to the risk involved.

Comparison: Adding Value vs Value Add

Even in the lowest risk deals, there are often ways to add value. 

However, not all deals with the ability to add value are considered “value add” relative to risk/return.

Again, similar terms with different meaning. Here are examples of how each might be used:

• Value Add: “We have a big appetite for risk at our company. We focus exclusively on value add industrial deals.”

• Adding Value: “The deal has a ton of upside because there are so many ways to add value in the first few years.”

We will focus on adding value in this series.

A Menu of Options: Choose Your Own Adventure

Those of you born in the 1970s or 1980s may remember a book series called “Choose Your Own Adventure”. In it, the reader started in chapter 1 and was faced with a choice at the end of the chapter. Choose one option, go to page 22. Choose a different option, go to page 45. This continued throughout the book.

Creating and executing your property business plan requires a similar approach.

You start by assessing the opportunity and options available to you. From there, you start executing the plan and adjust as you go.

You have to adjust because (i) you continue to learn more about the property and the impacts of your plan as you go and (ii) the world and circumstances are always changing.

A Variety of Approaches

I introduced the analogy of three types of cars to give examples of types of real estate in Daily Issues You Will Face While Owning Real Estate. They were:

1. A top of the line Mercedes

2. A reliable but basic Honda

3. A car that constantly breaks down

Understanding the type of property you have at acquisition and the type of property you want it to become will guide your business plan.

For example, you may buy a property that is beat up (#3) but have a plan to turn it into a clean, functional property (#2) by executing your business plan.

Or you buy a property similar to a Honda (#2) but plan to not put a dime into it during your hold period knowing that it may get beat up over time (trending towards #3) but you will be able to maximize the near term cash flow.

Your money. Your property. Your choice.

What’s Next

Next week I will expand on the menu of options by sharing specific details of the ways to add value to each of our five main asset classes: 1-4 unit residential, multifamily, industrial, retail, and office.

This will give you a comprehensive “menu” of what can be done to add value.

You will then be able to combine this menu with the characteristics of your specific property and goals to come up with your own business plan.

Get ready to get your creative juices flowing. 

This is the fun part!