October 22, 2019
When looking at commercial real estate investment opportunities, it’s important to know the different types. Core, Core Plus, Value-add, and Opportunistic investment strategies all come with different risk and reward profiles.
Because these four investment strategies possess different characteristics, it’s important to understand the differences before embarking on an investment.
Think stable and low risk. These properties would typically be Class A buildings that do not need any renovations of work. Core investments likely have a very low vacancy rate. They have long-term leases in place. Think of that well-respected apartment complex in your area or the strip center where you go to get your Starbucks fix. In terms of income and expenses, core investments are cash flowing. The monthly profits are not only easy to see on the financial statements but also more than sufficient to cover the monthly mortgage note on the loan required to buy the investment property.
Boring? Perhaps. But this is the kind of boring that won’t make you yawn. Instead, you may laugh all the way to the bank, since a core investment has a proven track record of consistent performance with their long-term leases.
Think growth and income with low to moderate risk. One may argue that the phrase is synonymous with value-add. However, a core plus property is actually the interjacent alternative that lies between core and value-add. These properties are cash flowing but definitely have the ability to increase cash flows through improvement. Maybe the wall covering in the foyer of a single-family property is in great shape but outdated. Or the metal halide lighting in an industrial building works fine but is not as energy efficient as fluorescent fixtures.
No, the core plus property isn’t the prettiest or most profitable investment property around. But the property also doesn’t require the hefty re-do budget of the opportunistic property. For core plus investments, we’re dealing with elements of the investment that simply need a minor tweak instead of a wholesale overhaul.
Think huge potential for growth with moderate risk. We’ve all heard the phrase “needs work”, and in the context of commercial real estate investment, this is where a value-add strategy comes in. A value-add property could be an older office or apartment building you’ve driven by a hundred times and hardly pay attention too because it looks outdated and maybe only partially tenanted. Perhaps there are maintenance items that have been ignored or overlooked by the current owner such as outdated roof materials, worn-out flooring, or the parking lot asphalt is broken up and pockmarked.
But adding value can mean more than just fixing or upgrading the obvious aspects of the physical property. A sharp investor can add value operationally by establishing internal financial controls, where none existed before, or by restructuring the debt on a property in order to improve cash flow. Once improvements have increased the net operating income of the property, investors aim to sell value-add properties and capture natural and forced appreciation.
In brief, the value-add opportunity is one in which the investor or sponsor clearly sees the path of improvement and efficiently makes the necessary changes.
Think extremely high growth potential and the riskiest option. If a value-add property seems like too much work, then an opportunistic property is even more out of the question for you. These properties generally have negative or zero cash flow. Opportunistic investments can include properties like vacant buildings, ground-up construction, and even land development.
In some cases, these properties have serious deficiencies that have driven other investors away. For a small apartment complex, there may be extremely low levels of occupancy due to the poor condition of the property. For an office property, a large plumbing leak in a vacant building may have ruined the flooring, thus preventing tenants from renting the space.
In any case, opportunistic investments are not for newbies. Instead, these investments are for investors who have waded in such deep water before and know their way out.
As you know, each type of real estate investment has its own risk profile. And the adage rings true. With greater risk comes the possibility of greater reward.
A first-time real estate investor in his early 60s with a low risk tolerance may prefer the relative certainty of a core real estate investment since he’s close to retirement age. However, an experienced investor in her early 30s with a higher risk tolerance may seek out the opportunistic property, since she has a longer time period until retirement and can give the investment time to produce a profit.
We can agree that buying a dilapidated, abandoned 45-unit apartment complex is inherently risky if you can’t get the property rehabilitated and leased up. But it very well could be rehabbed and rented, which is why it’s so important to match a given investment to your own particular risk tolerance, time frame, and overall objective.
At DiversyFund, we use a value-add strategy to build wealth for our investors. We seek out properties based on strong job markets, the best-expected returns, low risk, and other factors. All of the properties in our fund are already cash flowing. Once the fund renovates the units to increase the cash flow and the building’s overall value, we let the property naturally appreciate and we sell when the market is at an optimal condition. Learn more and get started today.