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Renovations, CapEx and ROI

by Amy Bigley Works

Click here to read on the StudentHousingBusiness.com

Crafting a relevant and balanced renovation strategy can lead to big pay-offs for operators and owners of student housing properties.

Right now, renovation is a hot buzzword in the student housing industry. With the right preparation and plan, a renovation can be a big pay-off for an owner’s return on investment, but it’s not always as simple as a fresh coat of paint or new appliances. Each property and market is different and requires its own dedicated research to understand if a renovation is needed and/or what type of renovation will offer the largest rent driver or value-add potential.

First Steps

For the River Park at Ohio University in Athens, Ohio, Homestead U executed a $1.2 million renovation for the 958-bedroom property. The crowning jewel of the renovation was the addition of an exterior amenity area, including a new resort-style pool, pool house and barbecue area.

For the River Park at Ohio University in Athens, Ohio, Homestead U executed a $1.2 million renovation for the 958-bedroom property. The crowning jewel of the renovation was the addition of an exterior amenity area, including a new resort-style pool, pool house and barbecue area.

There are many approaches to renovating student housing properties, but the first step is identifying properties and.solidifying a plan. On the acquisition side, there are two trains of thought on how to approach a new asset: 1) simply as a cash-flow property with no renovations, or 2) as a value-add property with potential rent increases from renovations. For many in the student housing industry, the potential of rent increases from renovations wins.

 

 

 

 

Creating a successful property with premium rents that compete with new product is a huge draw, and many companies have crafted business plans around that idea.

Chicago-based The Scion Group has spent the last six years purchasing older properties (five to 10 years old) from REITs and other companies with a renovation as part of the initial acquisition plan. Birmingham, Alabama-based Capstone Real Estate Investments (CREI) has infused more than $9.1 million in direct construction expenses for 2014-2015 delivery and has nearly $22.5 million in renovations slated for a 2015-2016 delivery across its portfolio. And Raleigh, North Carolina-based The Preiss Company spent more than $10 million on renovations as part of either acquisition or recapitalization plans.

For Santa Monica, California-based MJW Investments, turning Class B- and C-quality properties into B+ and A properties is the firm’s bread-and-butter, says Brennen Degner, director of asset management for the company.

“We operate on a relatively simple model, if we feel there is room in the rent roll for upward movement and we can establish a renovation number we’re comfortable with to close the loss to lease gap, we renovate,” explains Degner.

The Scion Group’s mindset is that most properties, if they’re older than three years, will need some sort of renovation to stay competitive and relevant in the marketplace.

“For us, it’s about asking whether a property can continue to be relevant in a particular marketplace with the new product, and how do we attract premium rents for an asset and still complete with the new product,” notes Mitchell Smith, senior vice president of The Scion Group.

What to Renovate?

Homestead U purchased The Ranch at Texas Tech in Lubbock, Texas, as a value-add opportunity. The company made modest renovations to the property, including completing deferred maintenance and a $400 per unit upgrade of freshly painted cabinets and new countertops.

Homestead U purchased The Ranch at Texas Tech in Lubbock, Texas, as a value-add opportunity. The company made modest renovations to the property, including completing deferred maintenance and a $400 per unit upgrade of freshly painted cabinets and new countertops.

“Renovating multifamily properties is like playing poker; each hand you’re dealt is different, therefore, you play each opportunity differently,” says Christopher Mouron, executive vice president of development/principal of CREI.

Careful market analysis and direct resident surveys are the best ways to determine what renovations will be profitable in any particular market, and each market, submarket or property-level tier can be hugely different. What residents are looking for in a close-to-campus property in California may be completely different from what students at a similar property in Utah are demanding. Second- and third-tier properties even have different expectations.

“We complete a thorough market study of fellow market competitors from a completion standpoint,” explains Kyle Barger, vice president of construction management for The Preiss Company. “If completion includes granite countertops and new furniture packages, and the property we are considering does not, then we know that an interior finish upgrade is necessary.”

Taking the time to fully understand the target audience for a property is key to creating and implementing a successful renovation plan.

Resident and prospect resident feedback is important to determining the needed renovations, especially in this day of social media. Property flaws or outdated amenities can easily become known and widespread across a marketplace, which is often detrimental to a property and its brand. A lot can be gleaned from listening to on-site management teams and residents, and researching what is being offered and what is working in the market.

“If your online reviews complain about dated interiors or how tired your gym is, they’re signaling that those areas are probably common barriers to lease for your sales team,” says Dave Anderson, president of Columbus, Ohio-based Homestead U.

Tony Landa, senior vice president of Birmingham, Michigan-based Lutz Real Estate Investments (LREI), echoes Anderson’s approach, noting that LREI utilizes its on-site management team, which maintains quality relationships with residents and has a pulse on students’ likes and dislikes. “The feedback helps solidify our plans for renovation and ensures that capital is being spent prudently,” says Landa.

In addition to understanding the targeted audience, it’s important to understand overall market growth and the potential impact it will have on occupancy and rents. Paying attention to supply and demand, including property offerings and renovations, is crucial.

“Increased supply in a market with stagnant demand can quickly turn a well-maintained Class B property into a Class C property simply because there is not enough demand to allow for appropriate rent differentials,” notes Anderson.

Through trial and error companies have been able to focus in on a few renovations that help boost a property’s appeal and, ultimately, rental rates across the board.

The Scion Group has seen huge impacts from the installation of hardwood-style flooring throughout a unit’s living and wet areas, replacing carpet in the bedroom and repainting the interiors with complementary wall and trim colors or accent walls, instead of the industrial spray all approach. Along with the interior upgrades, the company usually does a larger renovation on one of the property’s amenities — whether it’s doubling the size of the gym, redesigning the pool area or creating an updated clubhouse.

Other companies, like MJW Investments, have seen positive feedback from more amenity-focused upgrades, including new multipurpose sport courts, fire pits, barbeque areas and community centers. Renovations that improve and enhance resident life and social programming have proven to be truly successful for the company.

Additional renovations that typically result in positive impacts for a property include kitchen and bathroom upgrades, including new countertops, flooring, appliances and cabinetry; top-tier Internet and WiFi connections; flex space additions; private bathrooms; in-unit washer/dryers; and infrastructure updates.

The Preiss Company has seen great success with smaller renovations. Over the last seven years, the company has done 15 to 20 renovations ranging from $500,000 to $6 million. From the $500,000 to $900,000 improvements at properties in Myrtle Beach, South Carolina, and Statesboro, Georgia, to a $2.3 million renovation in Charlotte, the well-planned and executed renovations have proven successful for the company, notes Barger.

The Balancing Act

From small capital improvements to large-scale overhauls, a well-planned and executed renovation strategy can have a huge impact on a property, increasing occupancy, rents and revenue, but the balancing act between success and failure is a tightrope to walk.

Companies have to be transparent with current and potential residents, especially where rent increases are concerned. Adding features like a media room brings projects in line with students’ expectations of amenities. Pictured is a property owned by The Preiss Company.Residents deserve to know what they’re getting for a rent bump and how the upgrades will benefit them. Maintaining open communications with residents, on-site management and the renovation team can be tricky, but it’s a key step to creating a successful renovation strategy.

“There is truly no margin for error when making renovations to a property that has to be operational when students return,” says Davis Myers, business development manager with Atlanta-based Juneau Construction Co. “It is crucial to find the optimum balance between what will give you the most return and what is truly feasible in today’s world of construction.”

In addition to being transparent, renovations have to be completed within the student-housing cycle to maximize marketability and enhance lease-up potential. Going into a renovation with a detailed, well-timed plan and experienced team are key to creating a successful renovation with the least disruptions, from moving residents to construction delays.

The Pay-offs

Operators that renovate student-housing properties aren’t striving to compete one-on-one with the newest properties — that’s simply not possible when a property is five to 10 years old. But renovations do allow an owner to create the best value for property that is on par with the marketplace competition.

While the renovated property won’t be the newest, it will be able to offer the same or similar high-end finishes and amenities that renters are seeking at a fraction of the cost of a new property (but a higher rent than an unrenovated property).

Companies have seen positive impacts from small capital improvements to large-scale overhauls, and it really depends on the desired return and the current state of the property as to what renovations will be most beneficial.

“It’s hard to truly reposition a property with a ‘lipstick’ renovation, i.e. new flooring and/or paint,” says Mouron. “So CREI tends to ‘go big’ on its repositioning scope and renovation expenditures seeking to change the community’s entire market identity.”

Pay-offs differ wildly from property to property and renovation to renovation, and are dependent on a company’s approach. Some properties are positioned in markets with little room to drive rents and so a few property maintenance upgrades will keep the asset in rentable quality where other properties are situated in markets where there is potential for rent increases with the right combination of renovating and repositioning.

The most successful renovations are based on a company’s business plan and how it works with a property and its needed renovation and market, and, ultimately, the company’s desired return on investment.

LREI targets at least 15 percent return on cost for renovations for most properties, notes Landa. “For example, if a two-bedroom renovation cost $5,000, we’d expect to earn an additional $750 annually on the unit,” says Landa.

The Preiss Company targets capital expenditure improvements that can produce a 20 percent return and/or focuses on capital renovations that are necessary to sustain the property, notes Donna Preiss, president of The Preiss Company.

“We consider renovations to be value-add opportunities,” she explains. “Our experience has shown us that certain renovations create immediate and attractive yields, and we are always looking for these opportunities.”

The successes of student housing renovations can’t be underestimated, and the results speak for themselves. LREI achieved a 20 percent return on cost for improvements, including renovated kitchen and bathrooms, in-unit washer/dryers, upgraded common areas and a refurbished amenity package, at a two-property portfolio, which the company purchased in 2012.

The Preiss Company also targets capital expenditures that will increase rents and rental velocity — laminate floors can increase rents per bed by $15 to $20 and the cost of a laminate upgrade is approximately $2,500 per unit, which accounts for an annual return of 38 percent on the $2,500 invested, explains Preiss.

The Scion Group has successfully renovated 10 properties and currently has a portfolio of 20 owned properties with 15 of those communities at 100 percent occupancy. One of its most recent success stories is Village of Blacksburg in Blacksburg, Virginia. The 1,056-bed property, which is not pedestrian to Virginia Tech’s campus, was built in 1993. The property underwent a major renovation program in 2014, and The Scion Group increased rents by 14 percent as a result. The property was fully leased by March 2014 without any new concessions or incentives, and it’s on track to hit 100 percent occupancy again this year with an additional 6 percent rent increase.

For some assets, a spaced-out renovation plan makes the most sense. Homestead U acquired University Village in Columbus, Ohio, in 2011 and has been making strategic updates to the property, which was built in 1959, every year. From interior upgrades to the kitchens, bathrooms and laundry rooms to complete renovation of the leasing office and common area amenities and the recent renovation of pool and pool deck, which was completed in spring 2014, the property has a new highlight for each leasing year.

“With new student product coming online in Columbus, the strategy is to give our sales team something fresh and exciting to promote for each lease up and justify our annual rental increase,” explains Anderson.

Whatever the approach, the challenge for a renovation is to create enough value to increase a property’s rents to ultimately reposition the property and increase rents to recoup the capital spent on the upgrades. If done correctly, with thorough market research, experience and realistic expectations, renovating a student housing property is another way to stay active and relevant in the ever-competitive student housing industry.

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