Mismanaged Properties Can be Highly Profitable
by Petros S. Sivitanides, Ph.D.
Mismanaged properties, or underperforming properties (as they are often referred to) represent the third category of properties with big profit potential. This category includes two subcategories of properties:
a) properties that are not used in their highest and best use b) properties that are being used in their highest and best use but their earning capacity is well below their true potential given the advantages of their immediate and broader location Properties not being used at their highest and best use can provide high investment returns if the transition from their current use to the most profitable one is not very costly. In trying to evaluate whether a specific property falls under the category of mismanaged properties, one needs to ask the following questions: a) What is the strength of a specific location?
b) Are properties at this location being used in a way that takes full advantage of their immediate environment and accessibility advantages to surrounding communities and to the broader urban area?
c) Given the mix of people and activities in the neighborhood and conveniently accessible locations within its area of influence, what kind of use would earn the highest income?
The possibility and potential for repositioning is the key for identifying mismanaged properties that can be turned around successfully. Repositioning is the key concept because these properties usually require improvements in order to be brought to a qualitative and functional status that will allow them to attract tenants and increase income. Hence, a typical group of mismanaged properties across all types of real estate includes class-B and C structures at class-A locations. These properties usually require capital expenditures in order to be brought to a status that would capitalize on the full potential of their location. Examples of such properties are class-B office buildings at class-A commercial locations, or low- and medium-quality houses and apartments in high-quality neighborhoods. Investors need to have in mind, though, that not all class-B or C structures at class-A locations offer opportunities for big profits. For example, some structures may have remained at a poor and dysfunctional condition simply because the cost of improvement is too high, compared to the expected increase in income. For such buildings to truly qualify as mismanaged properties, the anticipated increase in income as a result of the property’s upgrade must be significantly greater than the cost of improvements. For this reason, in assessing the extent of mismanagement and the true value-increase potential of the property, extra caution is needed, with respect to assumed figures for occupancy, achievable rental rates, and required capital expenditures. The latter may involve façade work, renovation of lobby and common areas, updating of the mechanical equipment and building technology, the elevators, the parking structure, etc.
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1This is an excerpt from the book Profitable Real Estate Investing: A Value Growth Approach by Petros S. Sivitanides.
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