Increasing real estate value by adding kitchens

I had lunch with a long-time fellow HBS real estate guy yesterday. He told me about a new way to make money in real estate that I had not thought of.

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I was talking about reducing the load factor—converting existing space on a property that is not being rented into rented space. Load factor is generally an office or hotel term. It refers to space that you must have but that you cannot rent like lobbies, hallways, store rooms, stairs, elevators, and so on. You generally cannot eliminate it, but you can often reduce it.

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Like I once turned a storeroom next to a one-bedroom into the second bedroom of that apartment. Cost $900 and increased the rent on that unit by $30 a month—a $900 ÷ $30 = 30-month payback period.

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He knows a guy who buys reasonably well-located, run-down motels and converts them into efficiency apartments. That is not reducing the load factor. It falls under the category of use change: motel to apartment building or extended stay hotel.

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I often think about adding bedrooms as a way to increase value. Many think of adding bathrooms. But one rarely thinks about adding kitchens. I generally like adding SECOND bedroom, but I regard adding a third or fourth or fifth bedroom as generally not cost effective. That is, it may increase the property value but not as much as it costs let alone making a profit.

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Adding a kitchen, obviously can only be done where the current number of kitchens is zero. And it can only be done to a motel room when the room is large enough that the sleeping area left after adding the kitchen is adequately large.

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Typical per unit cost of this motel-to-efficiencies trick is about $10K for the acquisition plus $40K or $50K for the finished product.

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I once converted a large store room into a an efficiency apartment. It helped that there was another store room underneath for laying new plumbing lines. I had seen an exhibiter at the National Apartment Association convention who made and sold Murphy beds. I had one installed in that unit. In retrospect, I should have just gotten a sofa bed.

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When you think about it, much of value increasing in real estate is changing to a more appropriate use. America was all wilderness in 1600. Most of the use changes initially were to farms. Waterfronts were changed into docks and ports and seafood, transportation, or heavy industry. More recently, waterfront property has been changed to the more profitable, more appropriate use of view housing, hotel, restaurant, office. Hurricanes in FL and the Gulf of Mexico recently have often hastened this process by damaging old seafood processing/ship building-repair/docks in areas where water views are now recognized as valuable.

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Everyone is familiar with farms being turned into housing developments and lofts being turned into residential and office space. Before covid, low-rise urban areas were turned into mid-rise or high-rise as the land under them became more more and more valuable.

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In the appraisal business, all appraisals are supposed to start by asking the question, “What is the ‘highest and best’ (most profitable) use of the this piece of land today?” That is a like a “zero-base budget” mentality. That is, you do not assume that the current use is the best use.

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I often define experts as having ‘x-ray vision.” They look at the same thing as a layman, but see more than the lay man sees. It is more important in real estate investing than in many other fields.