Understanding the top three commercial real estate investment strategies is key to successfully investing in commercial real estate.
Core, value-added, and opportunistic investments all have unique characteristics that can be matched with an individual investor’s risk comfort level. They are also an important tool to use when narrowing down the various available investment options among different commercial real estate asset classes.
Core Investments Are Predictable
Core commercial real estate investments are properties that generate stable, steady, and predictable income. The core investment strategy is perfect for real estate investors looking for a low level of risk.
The Core commercial real estate investment strategy can be broken down into two segments: Core and Core Plus.
A triple-net lease (NNN) property is a good example of an investment made using the core investment strategy. Property leased to tenants using a triple net lease require very little hands-on management from the investor because the tenant is responsible for nearly every aspect of the property.
Core commercial real estate investments have low vacancy levels and established tenants with long-term leases in Class A buildings. Because of this, there is a very low risk that the income stream from the property will decrease. The tradeoff is that there is also a limited upside to the property income increasing during the holding period of the investment.
Core plus investments offer the safety and stability of core investment property, plus the opportunity for greater income growth potential. An office building that requires some light renovation in order to lease up and increase net operating income is a good example of a property purchased using the core plus investment strategy.
There’s a slightly higher risk level in core plus real estate investments, compared to core property. With the core plus investment strategy, a minor increase in risk is exchanged for the hoped-for gain in income from the capital invested in upgrades and improvements. Investors operating under the core plus real estate investment strategy should also expect to put a little more time and effort into the property while the updating is being done.
Value-Added Investments Offer Potential
Value-added commercial real estate investments have a moderate-to-higher risk level but also offer the potential for a bigger annual return. Property purchased using the value-added investment strategy offers very little core income to begin with. Investors add value to the property by investing additional capital in upgrades, boosting occupancy, and being involved with the property management and leasing teams.
Converting part of the floor plan of a traditional office building into coworking office space is one example of the value-added commercial real estate investment strategy. If the investor develops and executes the right strategic plan, ROIs from value-added investments can be nearly double the return from core property investments.
Opportunistic Investments Are Not For The Faint Of Heart
Real estate investors who are comfortable taking a lot of risk in exchange for a possible high reward will find the opportunistic real estate investment strategy to be just what they’re looking for. Opportunistic investors can expect to be involved in the day-to-day details of the investment – from detailed in-depth strategic planning, capital-intensive upgrading, and property conversion or development.
Because it can also take several years before an opportunistic investment generates a positive cash flow, investors need to be keen judges of commercial real estate market trends. An unexpected increase in vacancy levels or declining absorption rates can have a significant effect on the rate of return generated by opportunistic commercial real estate investments.
The Hudson Yards project in Midtown Manhattan and the Lumber Yard Office Lofts in the Midtown West office submarket of Atlanta are two examples of property developed using the opportunistic investment strategy.
Different Real Estate Strategies For Different Investment Philosophies
The top three commercial real estate investment strategies fall along different points of the risk and reward curve. Key features of the core, value-add, and opportunistic real estate strategies are:
Core real estate investment strategy:
- Similar to buying a fixed-income product like a CMBS or Treasury bill;
- Offers lower risk in exchange for relatively low rewards;
- High-quality tenants on long-term leases in Class A buildings are found in core real estate investments.
Value-added real estate investment strategy:
- Similar to investing in a CDO or buying shares in Google or Apple;
- Offers moderate risk in exchange for a higher reward from value added to the real property;
- Converting a traditional office building into coworking office space is an example of a value-added real estate investment.
Opportunistic real estate investment strategy:
- Similar to participating in a private placement for a new real estate development project or buying shares in an IPO;
- Offers the potential for a high return, but incurs a high level of risk over a longer period of time;
- Speculative real estate development aiming to benefit from Amazon’s new Long Island City HQ is one example of the opportunistic real estate investment strategy.