While it goes without saying that an investor’s objective is to minimize risk and increase profit before investing in one of these types of assets, there must be a definitive investment strategy to determine the level of risk and return associated with that deal.
It is important to note that returns, in this case, are derived either from appreciation of the value or an asset or cash flow. Moreover, the higher the risk level, typically as do the expected returns. The overall objective is to invest in an asset that we can increase in value with the potential for increased cash flow. Ideally, as a real estate investor, you would prefer an investment that was both low risk and high reward.
Let’s break down the 4 main strategies and what they mean.
Risk Level: low
These properties would typically be Class A buildings that need little to no renovations. Core investments can be considered lowest risk because they are often stable cash flowing investments and generate predictable returns. An example of this type of property is an office park that is fully occupied with long term tenants. You can find core properties in suburban cities and metropolitan areas.
Risk Level: low-moderate
Core plus is similar to core, typically not as high quality. Investors can increase cash flow through management efficiencies, slight rehab, and quality of tenants for cash flow. This asset type can be single or multi-tenant. A core plus property could be a shopping center with a Starbucks, Target, and Petsmart. Some cash could be used for future maintenance and parking lot repairs.
Risk Level: moderate to high
Value-add investment properties have potential to produce higher returns by taking an underperforming asset and improving it in some manner. The goal of a value-add investment is to increase net operating income. These buildings tend to have occupancy issues, management problems, and can require more technical work. Value add opportunities can be in recovering markets and secondary markets. A distressed 50-unit apartment complex could benefit from a value add through heavy rehab and an experienced management team.
Risk Level: High
Opportunistic real estate investments are the most risky and complicated projects to deal with. This strategy is the riskiest, because it involves the use of high leverage. Acquiring opportunistic properties often have negative to no cash flow in the beginning with potential to produce double digit returns. Examples of opportunistic investments are ground-up developments, redevelopment, or completely vacant properties. This strategy is best suited for experienced investors to manage the full lifecycle.
So which types of deals should you invest in? Investors with lower risk tolerance may consider investing in mostly core and core-plus investments. Investors aiming for higher returns can typically seek value-added and opportunistic investments at a higher risk. In order to evaluate real estate investments, it is important for investors to understand the characteristics and risk profiles of each strategy. A balanced commercial real estate portfolio may include these investment categories depending on the risk tolerance of the individual investor.