Simply put, value add is exactly what it sounds like. Value add is the commercial real estate version of fix and flip or, in some cases, fix, hold, and then flip. The first example is that of a vacant office purchased for $212,000. It has eleven rentable offices highly desirable for small businesses, lawyers, and interestingly auto brokers. Auto brokers are great tenants because they are legally required to have an office but are rarely present. There is virtually no wear and tear from them yet the rent rolls in. Currently ten of the offices are rented for a total of $35,820 annually. Expenses are $8,870 not including debt service of about $12,000. As an investor the net cash flow is $17,650 a year as a hold. Its’ sale value is now based on the NOI of $26,950. We could sell it on a 10% cap for around $270,000 for a gross profit of around $58,000. If we rent the remaining office for its market value of $400 a month or $4800 a year that would add another $48,000 in value added making it a potential sale of over $300,000 and bringing the gross profit to almost $90,000. If we had paid all cash we would only be getting about 8% return on our cash but we put in around $67,000 so our return on cash is around 25%. That is all based on still having that one vacancy. This kind of return is hard to beat not to mention the sale value that has been created.
The second example is a vacant building in Downtown Jasper, GA. We paid $160,000 all cash. It was rented to a restaurateur who we gave three months free rent as an alternative to tenant improvement money. He then spent about $75,000 building it to suit his needs. The tenant had an option to buy at $299,000 that expired two years from the lease signing. The tenant paid rent of $2,000 a month for a year and then exercised his option to buy. The tenant paid for the value that he created by being there. Granted it was at the “discounted” price of $299,000 but a year of income had already been received and the sale price of $299,000 was still almost doubling the original investment of $160,000.