Better than New?

In the 1970s, apartment developers built projects as fast as they could to cater to the baby boomers just graduating from college. Many of these complexes are now outdated and rundown, but they can offer prime opportunities to investors, who can renovate and reposition the properties — then raise rents. Once the dust clears from a repositioning project, an investor can look forward to double-digit returns for about 40% of the cost of building a new property, according to companies that specialize in repositionings.

These older apartment complexes are often located in urban areas with attractive demographics, including a fresh group of college graduates — the children of the Baby Boomers — and young professionals with high incomes. But these are also places where there's no opportunity for greenfield development. “Sometimes you can buy into a location that you can't build in,” says Jonathan Holtzman, CEO of Farmington Hills, Mich.-based Village Green Cos.

Village Green did just that when it purchased the 319-unit Parcfront Apartments in the historic West End section of St. Louis in the spring of this year. The three mid-rise apartment buildings, which were built in the 1920s, have been renamed the West End City Apartments, and the repositioning is scheduled for completion in the fall of 2003.

By purchasing and repositioning three high-rise buildings built in the 1920s, the company was able to enter a popular shopping and entertainment district in a location where zoning regulations did not allow new construction.

In suburban Long Island, N.Y., Home Properties of Rochester, N.Y., seized on the chance to reposition the Lake Grove Apartments because the location offered attractive demographics — the complex is surrounded by $400,000 to $500,000 homes. Restrictive zoning rules and time-consuming zoning procedures make it difficult for developers to build new projects in Lake Grove.

The aging of America's apartment buildings has caused a significant industry shift, says Marc Obrinsky, vice president of the National Multi Housing Council (NMHC). In 1978, 77% of the country's existing apartments were more than 10 years old. By the close of 2001, that percentage jumped to about 90%. “By comparison, today's apartment stock is older, so there is a greater need — and more opportunities — for apartment upgrading,” Obrinsky says.

Bernard Quinn, vice president of Home Properties, has identified the same dynamic in urban centers across the country. “There are not a lot of new sites in New York, Chicago or Philadelphia, but there's a lot of opportunity for repositioning,” he says.

Typical renovations in a repositioning include kitchen and bathroom upgrades, and installation of telecommunications and electrical wiring. To attract new residents, investors often provide new amenities such as health clubs, business centers and ground-floor retail. They also might add perks such as building concierge services. “If you can take the best of the past and mix it with the technology of the present, it beats either old or new,” Holtzman says.

Alexandria, Va.-based AvalonBay Communities believes it achieved the best of the old and new when it repositioned the Longwood Towers in Brookline, Mass., in 1998. When the company renovated the trio of towers built in 1926, it preserved the historic character of the buildings while overhauling the electrical systems, updating the interiors of the apartment units and restoring the façade.

“We lived with the restoration for a year to identify areas of opportunity,” says William McLaughlin, regional vice president of development for AvalonBay. To generate more revenue from the project, the company worked with the local building commission to gain approval to add an entire extra floor of units to replace an old ballroom.

Retaining Residents

Maintaining occupancy levels helps contribute to the profitability of a repositioning. To ensure a steady stream of revenues, Village Green typically offers incentives — such as allowing a resident to stay in an upgraded unit at the same rental rate for several months — designed to encourage tenants to stay during the transition.

“We don't want to move too fast since we are concerned with maximizing resident satisfaction and as a result, income,” says Diane Batayeh, senior vice president of acquisitions for Village Green.

At the Lake Grove Apartments on Long Island, Home Properties employed a gradual repositioning strategy. The company's first move at the apartments was to collect rents more diligently than the previous owners. While the 27-acre apartment community's occupancy rate was in the 95% to 97% range upon acquisition, the “economic occupancy,” or percentage of actual rents collected, was as low as 75%.

The immediate adoption of a more strict collections policy was followed by the construction of a new community center and exterior improvements, including new balconies, windows, entry doors, signage and landscaping. The owner also installed new roofs, boilers, and sewer and drainage systems.

The exterior improvements allowed the company to begin raising rents by $200 to $300 per month. After the exterior improvements were nearly completed, Home Properties began renovating the interiors of the apartments and raised rental rates another $100 to $200 per month upon the completion of each unit.

“The key to a quick turnaround was the good group of contractors we assembled to know the drill,” notes Quinn. He added that the speedy completion of the interior improvements — including upgraded kitchens and bathrooms — helped the firm maintain high occupancy rates and income streams during the renovations.

Average rental rates increased from $781 per month before the repositioning in 1997 to $1,228 per month at the end of the third quarter of 2002. Net operating income rose from $830,000 in the third quarter of 2001 to $963,000 in the third quarter of 2002, a 16% gain.

Getting the Word Out

Home Properties did not launch a marketing effort to attract residents at Lake Grove Apartments, but instead relied on the “curb appeal” of the renovated property. Other companies, such as Village Green, rely on aggressive advertising campaigns to get the word out on their repositioning plans.

For Village Green, re-branding a property is the crux of its repositioning effort. “Changing the name helps to disassociate the property with any past image problems it may have had,” says Batayeh.

In Royal Oak, Mich., a suburb of Detroit, Village Green applied its Village Park brand name to a tired 1960's apartment complex formerly known as Gardenia Gardens and Washington House apartments. When the company purchased the 339-unit property for $13 million in December 1999, the occupancy level was nearly 100%.

However, rental rates were significantly below market. The complex was family operated and residents consisted of senior citizens, single renters and families. New residents were identified during an outreach program that targeted area businesses.

During the repositioning project, Village Green spent $7.2 million on renovations, or roughly $20,000 per unit on top of the $38,400 per-unit cost of acquiring the complex. Renovations included new balconies, masonry repairs, replacement of boilers and installation of new air conditioners, along with cosmetic improvements such as new paint. The company also added a business center, a racquetball court, a fitness center and a new clubhouse with a bar and entertainment area.

Currently in its first year of stabilized returns — which developers typically consider to be the third year following the acquisition of the property — the complex's rental rates have increased from $558 to $818 per month and gross revenues have jumped from $2.27 million to $3.34 million per year.

Exit Strategies

In the first year following the acquisition of a property, the majority of the money has been spent on upfront repositioning costs, but an increase in revenues usually has not been realized. During the second year, the repositioning is usually complete and there is still some lag in the income stream. In the third year, the investor expects cash returns to reach their target.

Some companies, however, don't wait until the third year for the desired profits to kick in. Home Properties looks for a 12% return on any capital improvements immediately within the first year.

Village Green, AvalonBay and Home Properties all are long-term holders of the properties they reposition, but Irvine, Calif.-based Granite Investment Group is an opportunistic investor that often sells a property soon after the repositioning is complete.

That was the case in September 2000 when the company purchased the 148-unit Park Villa Apartments in Redlands, Calif., a suburb of Los Angeles, from a private owner for $8.5 million. The company only invested in minor improvements at an average cost of $4,000 per unit.

The limited costs associated with fixing up the interiors — no expensive countertops, cabinets or appliances were required — helped keep the costs down, as did the good condition of the roofs and HVAC systems.

The southwestern-style 1986 property was 90% occupied when Granite Partners bought it, with a NOI of approximately $490,000 per year. However, rents were depressed at $580 per month, roughly $150 per month below market levels.

The asking rents for new residents were immediately increased upon acquisition by approximately $150 to $200 per unit. In addition, rates were increased by an average of $75 to $100 per month as existing leases expired. Six months after the majority of the renovations were completed, the firm accepted an unsolicited offer from a private company. Although the company will not disclose the sale price, it says the sale resulted in a return on its equity investment in excess of 70%.

Successful repositioning projects can bring benefits to more than just the buyer and the seller. Residents and the surrounding community also appreciate the upgrades to a property that has been long neglected, says Batayeh.

“You have taken an asset that is typically in substandard physical condition and transformed it into an asset that the municipality can be proud of.”

Margy Sweeney is a Chicago-based writer.

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