This project's strategy is consistent with the company's successful value-add track record, specifically our 2012 fund, which was a response to the global financial crisis. The fund purchased distressed assets, modernized the units, and improved building common areas and infrastructure. On this project in particular, our process resulted in a cap rate increase of 125 basis points, representing a ~50% increase in project-level net operating income over the development period. This project will also pursue funding offered through the Inflation Reduction Act to improve energy efficiency.
Value Add
ArtHaus Oakbrook
The Opportunity
We were presented an "off-market" opportunity to acquire a portfolio of 200-units across three buildings. The owners of the property were seeking to liquidate after 35 years of ownership due to partnership issues. When we entered into discussions, the property was struggling with occupancy at only 63%. Due to the distressed nature of the asset, we were able to acquire the property for roughly $220k per unit, a discount to a pre-COVID value of ~$260k per unit. This resulted in a ~$9.0 million discount. Located in a desirable area of Oakland near Lake Merritt, the deal had strong fundamentals that would create attractive returns with the proper improvements.
Our Approach
At the time of acquisition, the property was roughly 63% occupied with the occupied units achieving 20% below market rents on average. Contrary to most of our value-add projects, the buildings were generally well maintained with minimal deferred maintenance. Additionally, there were a series of unused garage spaces that had ADU potential. These characteristics set the stage for us to deploy our proven value-add strategy.
01
Identify the Opportunity
In our typical value-add strategy, we look for deals in attractive markets. These areas include urban centers with a lack of affordable housing options, an underserved demographic, and contrarian market sentiment. This was consistent for Oakbrook and Palmcrest, which are situated in close proximity to Lake Merritt.
02
Select the Best Site
We look for sites with strong market fundamentals including: access to mass transit, proximity to entertainment and recreational options, large employment and education opportunities, and excess space to increase the property's density. This location met this criteria with mass transit options, outdoor recreation, bars and restaurants as well as major employment opportunities.
03
Improve Operations & the Resident Experience
Our first order of business, upon acquisition, is to improve the quality and longevity of the building by updating the existing units, improving common areas, adding functional amenities like fitness options and bike storage, adding tech-enabled access control and package storage, and upgrading the building infrastructure (roof replacement, seismic support, etc. ) as needed. This project was unique in that it had a low occupancy rate (63%) which gave us the ability to improve a substantial portion of the building from the onset. This improved net operating income in the first year, which is exceptionally fast.
The addition of new amenities, like a functional fitness center, was accomplished by converting existing underutilized square footage. Improvements to the common areas and building exterior were also implemented as shown below.
Building and Common Area Improvements
Before
04
Increase Density
One of the primary focuses of our value-add strategy is to increase the unit count, and ultimately the density of our projects, by adding Accessory Dwelling Units or "ADUs" where possible. By leveraging state legislation, we are able to build new units on existing properties and subdivide large, inefficient unit layouts to add new studio apartments.
Garage Conversions
Before
05
Improve Energy Efficiency
As part of the unit improvements, we added new electric systems and efficiencies to them. This includes new electric appliances, upgraded service systems, new wiring, and new insulation. Using the inflation reduction act, these activities will qualify for new rebate programs, which we are anticipating to reduce the overall cost of improvements by up to $14,000 per unit. These rebates will also apply to the new units we add to the building.
In addition to improving the energy efficiency of the building, we will be adding a new solar power system to offset a portion of the building's energy consumption. Because many of the improvements at this project took place prior to the passage of the IRA, we were not able to initially capture these rebates but will over the course of the hold. Part of the inflation reduction act allows us to secure new tax credits for the creation of solar power, which will reduce the installation costs of those systems.
Project Results
These improvement projects gave the building a much-needed modernization. The new look and feel of the lobby and common areas give the building an improved sense of arrival for our residents. The new fitness center provides better amenities and the upgraded units provide a heightened living experience. To date, we have turned over 100 units, increased the overall unit count by 9% with the addition of ADU's, and increased average rent by 18%. The property is now 94% occupied. These activities more than doubled the property's net operating income and increased the value of the property dramatically.
| DESCRIPTION | COST | NOI | ROI | % OF BASE NOI | CAP RATE |
|---|---|---|---|---|---|
| Building at acquisition | $44,000,000 | $1,568,000 | 3.56% | 100.00% | 3.01% |
| Value-add activities | $8,177,000 | $1,814,000 | 22.18% | 115.69% | 3.48% |
| Net project total | $52,177,000 | $3,382,000 | 6.48% | 215.69% | 6.48% |
| VALUE-ADD ACTIVITIES - DETAIL | COST | NOI | ROI | % OF BASE NOI | CAP RATE |
|---|---|---|---|---|---|
| Renovation (Operations and Building) |
$6,325,000 | $1,400,400 | 22.13% | 89.29% | 2.64% |
| Densification (Add units) |
$2,026,000 | $284,000 | 14.02% | 18.11% | 0.54% |
| Subtotal | $8,351,000 | $1,684,000 | 20.17% | 107.40% | 3.23% |
| Electrification (Solar and Energy Improvement) |
$666,000 | $130,000 | 19.58% | 8.29% | 0.25% |
| Reduction (Inflation Reduction Act Credits and Rebates) |
$838,000 | - | - | - | 0.05% |
| Total Value-Add Activities | $8,177,000 | $1,814,000 | 22.18% | 115.69% | 3.48% |
Conclusion
This project is a great example of the capability of our value-creation process, which we will implement across the Distressed Opportunities Fund. Utilizing our extensive network, we are able to find assets at a low cost basis and, and through operational improvements (which reduces the loss to lease and overall operating expenses) as well as upgrades to units and common areas, can create substantial value, delivering attractive returns to our investors.
