Like many asset classes, commercial real estate investors have a number of investment options from which to choose. The options tend to be segmented by their risk/return profile and investors can mix and match them to create a portfolio that matches their own risk tolerance.
In this article, we will discuss one such option known as a “core” holding. We will describe what it is, why they matter, what typical returns look like, and how to invest in them. By the end, investors will have the information necessary to determine if core holdings are a good fit for their own portfolio.
At First National Realty Partners, we specialize in the purchase and management of best in class commercial retail centers, which could be considered core holdings in some cases. To learn more about our current investment opportunities, click here.
Core Real Estate Defined
To use a real estate analogy, a core holding is equivalent to the foundation of a building and they are the properties upon which a commercial real estate investment portfolio can be constructed. They aren’t so much a specific property type or asset class as they are a risk profile. General characteristics of core holdings include:
- Age: New or like new, with an age less than 10 years.
- Condition: Excellent condition with little or no deferred maintenance.
- Market/Location: Top tier growth markets with high traffic/high visibility locations.
- Tenants & Lease: High quality tenants on long term leases. Occupancy is full or near full.
- Leverage: Low leverage, usually in the range of 40% – 50%.
- Finishes: High end finishes like marble, granite, and/or wood flooring.
Given the characteristics described above, core investments have a low risk / low return profile. In general, individual real estate investors can expect annual returns in the range of 4% – 8% that consist of income with little or no chance for major price appreciation.
Examples of Core Investments
Classification of core properties can be inconsistent, but typical examples include Class A multifamily properties in a prime location, high rise office buildings in the central business district of a major city, or a commercial retail center with a top tier anchor tenant.
Pros and Cons of Investing In Core Properties
Real estate investors like core properties for their stability and consistency. Because these are relatively new properties in excellent locations with top tier tenants, they tend to have stable cash flow, lower credit risk, and high levels of tenant retention. As a result, they tend to deliver remarkably consistent returns over time.
But, the flip side of stability and consistency is that these features are priced into the asset. This means that core properties can be expensive and their returns lower than other options.
For these reasons, core properties tend to be a good fit for investors who prioritize capital preservation and income versus growth.
How To Invest in Core Real Estate Properties
Broadly, real estate investors have two options with which to gain exposure to core properties, public and private.
Public Investment
For individuals who pursue a public investment strategy, their most likely option is to purchase the publicly traded shares of a real estate investment trust (REIT) or mutual fund that specializes in the purchase and management of core properties like retail, multifamily, industrial, or office. For example, Camden Property Trust is a REIT that could be considered a core holding because they develop and invest in multifamily assets in tier one markets throughout the United States.
The major benefit of a public investment is their liquidity and diversification. Because the shares are publicly traded, they can be bought and sold with relative ease by anyone with a brokerage account. In addition, REITs may own tens or hundreds of properties, so they provide a high degree of diversification within a single share. But, the downside is that investors often have little or no say in which properties their capital is used to purchase.
Private Investment
Or, if an investor chooses to pursue a private investment strategy, they could invest in privately traded shares of individually syndicated deals, private REITs, or in some cases they could just purchase the property themselves directly.
The major benefit of the private real estate approach is that investors have more control over how their capital is allocated because they can choose which property to purchase directly or which individually syndicated deal to invest in. But, the downside is that private real estate investments tend to be less liquid because shares are not bought and sold on public exchanges.
How Core Properties Differ From Other Categories
While the specific boundaries are somewhat loose, there are three other common commercial real estate investment types: core plus, value-add, and opportunistic investments. They are described below in order of their risk/return profile.
Core Plus Investments
In terms of risk and return, core plus properties are the next step up the scale from core holdings. A typical core plus investment is characterized by properties with good – not great – locations, stable income, high quality tenants, slightly dated finishes, low to moderate vacancy rates, and 50% – 65% leverage. Examples of a core plus real estate investment could include a Class B apartment building or retail center.
As a result of the slightly increased risk profile, core plus investors require a slightly higher return. They typically expect annual returns in the range of 8% – 12% through a combination of income and some growth. Core plus investment strategies tend to be a good fit for investors with slightly higher risk tolerance and a desire for some capital growth.
Value-Add Investment
The second step up from core investments are value-add properties. A typical value-add property has a fair to good location, dated finishes, medium to high vacancy levels, and some amount of deferred maintenance that must be addressed. The goal of a value add investment strategy is to purchase the property for a good price and to invest some amount of money in renovations and physical improvements to bring the property up to core or core plus standards.
The additional risk in a value-add real estate investment comes from the execution risk of the renovation project and the increased leverage taken to finance it. As a result, expected returns for value-add investors tend to be in the range of 11% – 15% and consist of income and growth. Value-add investments tend to be a good fit for investors with a moderate risk tolerance and a desire for capital growth.
Opportunistic Investments
At the other end of the risk/return spectrum are opportunistic investments, which are the least predictable, but offer the highest potential upside. Opportunistic properties tend to have high levels of debt and vacancy and they may need major repairs and/or a complete repositioning. Opportunistic investments also include ground up development because investors may have to go months or years without receiving any income.
Given the high risk, an opportunistic strategy requires the highest return, typically 20%+. However, there can be a high degree of variability. For example, in a ground up development, investors may not see any return for multiple years while the property is under construction. Once construction is complete and units are leased or sold, the return ramps up and can be significant if the project is successful. Opportunistic investments tend to be a good fit for investors with the highest risk tolerance and/or longest time horizons.
Between these four categories, each investor should be able to find one or more opportunities that are a good fit for their own investment objectives and risk tolerance.
Core Real Estate & Private Equity Firms
Private equity firms offer a variety of investment strategies, including those that seek to generate returns from core properties. As their name suggests, “private” equity investments fall into the private category described above.
For investors thinking about partnering with a private equity firm, it is important to complete due diligence on their approach, strategy, fees, and philosophy to understand exactly how they operate and to ensure it is a good fit for their own approach.
Summary of Core Real Estate Funds & Properties
Core real estate properties are those that make up the foundation of a commercial real estate investment portfolio. These are properties that have top tier locations, high end finishes, low leverage, and full or near full occupancy. As an investment they offer stable, reliable, income, but little to no chance for major price appreciation.
Examples of core investments include Class A multifamily properties or high rise office buildings in the central business district of tier 1 cities, like New York.
Individual or institutional investors can gain exposure to core properties through publicly traded investments like REITs or through private transactions like those with a private equity firm.
Core investments are one of four major commercial real estate investment classifications. In order of their increasing risk/return profile, the other three are core plus, value-add, and opportunistic.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets well below intrinsic value, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
If you are an Accredited Real Estate Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or info@fnrpusa.com for more information.
