Every commercial real estate investor has different levels of risk tolerances and different required rates of return, time horizons, preferred property types, and asset classes. To accommodate these differences, the commercial real estate industry has developed a categorization system to describe the various aspects of an investment opportunity. These categories include core investments, core plus investments, value-add investments, and opportunistic investments. Each category is described in detail below.
Core Investments
If a commercial real estate investment portfolio was a building, core investments would be the foundation. Core investments are high quality, low risk assets and offer the most stable cash flows.
A typical core investment is characterized by low leverage (40% – 50%), stable and predictable income, new or like-new construction, high-end finishes, and no major structural or operational issues. In addition, core investments typically have an excellent location with full or near full occupancy with credit tenants on long-term leases. Examples of core real estate properties include Class A multifamily assets, high rise office buildings, or high-end retail shopping centers.
Average Annual Returns for Core Investments
Given core investments’ relatively low risk profile, investors can typically expect annual returns in the range of 4% – 8%. Returns tend to come in the form of income with little to no chance for major price appreciation.
Who are Core Investments a Good Fit for?
Core investments tend to be a good fit for individual investors who prioritize stable income and preservation of capital.
Core Plus Investments
Moving up the spectrum of risk and return, core plus real estate investments offer slightly higher risk and a slightly higher returns than core investments.
A typical core plus investment is characterized by properties with a good – not great – location, stable income, high quality tenants, slightly dated finishes, low to moderate vacancy rates, and 50% – 65% leverage. Core plus real estate may have some tenant leases that are coming up for renewal in the near term, which adds to the vacancy risk. Examples of a core plus real estate investment could include a Class B apartment building or retail center.
Average Annual Returns for Core Plus Investments
As a result of the slightly increased risk profile, core plus investors require a slightly higher return. Investors typically expect annual returns from core plus investments in the range of 8% – 12% through a combination of income and some growth.
Who are Core Plus Investments a Good Fit for?
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 Investments
The next step up the risk/return spectrum is a value-add investment, which offers the chance for an even higher return with moderate risk.
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 market standards. Renovations could range from minor (new paint and carpet) to major (new roof and structural changes) and they are designed to attract new tenants at higher rental prices.
Average Annual Returns for Value-Add Investments
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.
Who are Value-Add Investments a Good Fit for?
Value-add investments tend to be a good fit for investors with a moderate risk tolerance and a desire for capital growth.
Opportunistic Investments
Opportunistic real estate investments are the riskiest type and have the least predictable cash flows. They also offer the chance for the highest returns.
Opportunistic properties tend to have high levels of debt and vacancy. The property may need major repairs and/or a complete repositioning. Opportunistic properties could also include ground up development where investors may have to go months or years without seeing any income.
Average Annual Returns for Opportunistic Investments
Given the high risk, an opportunistic strategy requires the highest return, typically 20%+. However, there can be a high degree of variability in opportunistic investment returns. 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.
Who are Opportunistic Investments a Good Fit for?
Opportunistic investments tend to be a good fit for investors with the highest risk tolerance and/or longest time horizons.
Why Do These Categorizations Matter in Commercial Real Estate Investing?
The categorization of core, core plus, value-add, and opportunistic real estate investment strategies matters as a way of providing individual real estate investors with information about the risk/return profile of their potential investment. This way, investors can match their own preferences to the real estate investing strategy to ensure there is a good fit.
For example, an older investor at or near retirement age whose priority is income and capital protection would likely be a good fit for a core investment. On the other end of the spectrum, a younger investor with a high tolerance for risk, long time horizon, and an appetite for growth could pursue a value-add or opportunistic strategy.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. We leverage our decades of expertise and our available liquidity to find world-class, multi-tenanted assets below intrinsic value. In doing so, 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 Investor and would like to learn more about our investment opportunities, contact us at (800) 605-4966 or info@fnrpusa.com for more information.
