The Hutchins Palms apartments at 535 West Hutchins Place in San Antonio, Texas is a great case study on a value-add property deal combined with a refinance opportunity. That means, in plain English, buy the asset, increase the value, refinance, return equity to investors, continue to operate the asset.
This case study illustrates how the investors in this deal were able to get a “free” property that continues to produce double-digit cash on cash returns. This property was purchased in 2016, refinanced and after only 12 months under ownership provided the investors with triple-digit returns. Sounds good, huh? Think about this for a second, after 12 months, investors got all their money back through a refinance and they still own the property. Now that they have no money invested, they are still getting double digit cash returns.
The Internal rate of return (IRR) on this investment is expected to be 44% for a 5 year investment.
Sounds good right? Want to know how that was done? Keep reading.
I will dissect how this deal worked and provide actual numbers, pictures and business plan details.
Property Overview
The property was a great find. It was a perfect setup for a value-add opportunity. Hutchins Palms Apartments is a 45-unit apartment complex in San Antonio, Texas. This property was built in 1986 and was a prime candidate for the value-add strategy. Not only this, but there was built in equity that could be extracted within the first year.
This property’s units had dated amenities, below market rents and inefficient operations. Further, this apartment complex is in a great real estate market with growing demand and a good employment base. So the strategy was simply to:
1. Install new property management
2. Inject capital to renovate interiors and exteriors, raise rents and increase Net Operating Income (NOI)
3. Reduce operating expenses to further improve NOI
Business Plan
The property was suffering lower than normal physical and economic occupancy. The strategy was to reposition the property. This simply means, make the property more appealing on the interior and exterior and raise rents while improving the demographics of the tenancy. Modern amenities and a fresh exterior would appeal to the targeted demographics and enable a turn around.
Capital renovations = Rent increases
$154,500 of capital expense was invested within 8 months of the acquisition. This money was invested primarily in interior renovations of 25 of the 45 units as well as exterior renovations.
The capital improvements on the first 55% of the units was completed within 8 months. This included:
- Interior rehab of kitchens, baths, fresh paint and ceiling fans for $3k a unit.
- Install new amenities such as laundry machines, BBQs and a dog park
- Repair and repave the driveway, porches and breezeways
- Improve exterior lighting
Exterior Renovations
Exterior renovations are important. If the property lacks curb appeal and does not seem to fit to your desires, you will simply drive past and not stop when you are looking for a new apartment. The outside gives an indication of what you can expect on the inside. In the pictures below, you can see before and after images of the exterior renovations done. This gives a good impression to the current residents as well as the neighborhood properties that things are improving.
Outside before renovations:
After renovation 1:
Outside 2 before renovations:
After renovation 2:
Exterior Lighting
The exterior lighting before the renovations was lacking. Poor exterior lighting gave the feeling of an unsafe and impoverished environment.
New energy efficient exterior lighting was installed. This created a safer and cleaner impression as well as reduced operating costs.
Before:
After:
Before:
After:
Interior Renovations
In addition to renovating the outside of the property, the interiors were renovated as well. Within 8 months, 55% of the units were fully renovated. This enabled rental rates to be raised closer to market averages and to burn down the loss to lease numbers.
Bathrooms and Kitchens
The bathrooms before renovation were dark with a brown counter top and mirrors without a frame or trim.
The renovated units have updated white cabinetry, white counter topics, better lighting and an updated mirror which gives a more modern and clean impression.
Old bathroom:
Renovated bathroom:
The Kitchens before renovations had beige / coffee cream colored appliances.
The renovated units had fully updated black appliances as well as fresh paint.
Kitchen before:
Kitchen after:
Operating Expenses
If you have read my eBook or read the blog articles on my site, you will understand that Net Operating Income is a result of the rental income minus the operating expenses.
On this property, we were able to raise rental income which is the primary driver and reduce operating expenses
Operating expense reductions of roughly $100 per door per month takes a lot of energy, focus and experience to achieve. These were realized by the following key actions
- Replacement of prior fulltime property manager with a part-time property manager. There is no need for a full-time property manager on an apartment complex less than 90 units or more.
- Resolved all long-term outstanding maintenance issues.
- Renegotiated maintenance contracts.
- Fixed water leaks
- Replaced all common area lighting with LED lights to reduce electricity costs.
To illustrate how attention to operating costs can make a big impact on the bottom line, here is a chart of the monthly water bills. See the trend?
Through analysis of data, comparison against norms of the area and other properties, an abnormality was identified. Water bills were higher than should be expected. They had been for years. Water leaks were existing through out the property and by repairing the leaks, the savings of $700 per month were realized as well as a good feeling of conserving the environment.
The same approach was taken for electricity. Initial analysis shows electricity expenses for common areas to be high. Identification of common area lights with faulty sensors revealed that some lights were continuously burning electricity. To further reduce costs and provide a positive environmental impact, LED lights were installed in common areas.
Financials and Performance
The property was purchased in 2016 for $1,572,000. Deferred maintenance and capital repairs were needed. An initial budget of $154,500 was reserved which would allow for the repairs to be made and the business plan to be realized. Additional capital for repairs was retained from rental income.
The majority of private equity real estate investments or corporate leverage buy out transactions involve a combination of investor equity and debt financing. Debt allows for the investor equity to be amplified. This means that for every dollar of equity, 4 dollars of property can be purchased. Also, it means that the returns the investor will realize are amplified compared to if the deal was financed with 100% equity. This deal was no different.
In fact, the bank was willing to finance the renovations as well as the purchase of the property. Something that is not always the case.
A Loan to value of 80% was taken. That means a loan of 1,257,600 was provided
| Purchase Price | $1,572,000 | |
| Closing Costs | 113,000 | |
| Bank Loan | (1,257,600) | 80% LTV |
| Investor Equity | (430,000) | 20% Investor equity |
The renovations
resulted in the ability to increase rents by $86 a door.
This additional rental income and expense reductions resulted in an increase of
NOI from $123k a year to $176k a year (43% increase). This allowed for
the investors to refinance the deal resulting in all investor money being paid
back and allowing investors to continue to own the property and receive monthly
income for free.
| YEAR 1 | YEAR 2 | YEAR 3 | |
| Income – Rents/Laundry | $381,881 | $393,337 | $405,137 |
| Operating Expenses | $206,470 | 210,599 | $216,916 |
| NOI | $175,411 | $182,737 | $188,220 |
| Mortgage & Cap Ex Payment | $74,981 | $105,563 | $105,563 |
| Net Cash Flow | $50,740 ($49,690*) | $57,174 ($20,000*) | $62,657 ($20,000*) |
| Cash-on-Cash return | 11.8% | 13.2% | 14.5% |
| Refinance Distribution | 105.3% ($452,632) | NA | NA |
| Cumulative returns | 117.1% | 130.3% | 144.8% |
Lessons Learned
The Hutchins Palms apartments is an extraordinary deal! This apartment provided investors with a 11.8% cash on cash return and paid investors back all capital plus 5% within a year.
This is a total 1-year return of 117% (116.8% to be precise.) Further, after the refinance and the return of all capital to investors, the investment paid a 7% return on the original invested capital in years 2017 and 2018..
Let’s turn this into real numbers for an investor. If you were one of the lucky investors into this small deal, and put in $100,000, here is what your cash flow would look like.
Investors put in $430,000 to buy and renovate the Hutchins Palms apartment complex and within 12 months they were able to refinance and take out $452,000. A
Not all deals have a motivated seller where there is 50% equity recapture available within just a short and “cheap” renovation. This does show, in a factual case study, what can be done however.
Nor your ordinary deal
This investment was extraordinary. Not all investments perform like this. 100% or more in 1 year is unusual. 100% over the course of the holding period is more normal.
In this deal, investors put in $430,000 to buy and renovate the Hutchins Palms apartment complex and within 12 months they were able to refinance and take out $452,000.
Not all deals have a motivated seller where there is 50% equity recapture available within just a short and “cheap” renovation. This does show, in a factual case study, what can be done however.
- Right Financing Structure
- Strong Experienced deal sponsor
- Strong property manager
- Market fundamentals
Want to invest in deals like this?
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