There is a commercial real estate investment strategy for investors of every type of risk tolerance and passive investment structures for investors of varying investment objectives and timelines.
Pick Your Strategy.
Commercial real estate investment strategies fall into four segments according to risk, quality, and potential return: Core, Core-Plus, Value-Add, and Opportunistic, from lowest to highest risk.
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CORE – Low Risk (7-10% annual returns)
Core investments are typically low-risk and require no improvements or active management. Offer lower risk, lower returns but stable, consistent cash flow from established, high-caliber tenants locked into long-term leases. The majority of expected return is generated mostly from cash flow vs. appreciation.
CORE PLUS – Low to Moderate Risk (8-10% annual returns)
Core Plus properties offer the ability to slightly improve cash flow through minor property or management improvements or by improving tenant profile.
Core Plus properties require active management due to a more diverse tenant mix and less predictable cash flow. Compared to Core properties, a higher portion of a Core Plus property’s expected return will be generated from appreciation due to potential increased value from property improvements.
VALUE-ADD – Moderate to High Risk (11-15% historical returns)
Value-add properties underperform at cash flow in terms of cash flow and have the potential to see substantial bumps in income through improvements in occupancy, rents, decreases in expenses through cosmetic, structural, and operational value-adds. Total expected returns are generated both from cash flow and appreciation.
OPPORTUNISTIC – High Risk (20%+ historical returns)
Opportunistic investments are the riskiest of all types of CRE investment strategies. Opportunistic properties involve complicated long-term projects (3+ years to see returns), including ground-up developments, land development, or repositioning a building from one use to another.
Pick Your Property Type And Condition.
Passive CRE opportunities are differentiated by investment strategy and the condition and location of the property as well – classified by the letters A-D.
Class A properties are newer – built within the last ten years – and located in the most desirable locations. They come with high-quality tenants, little to no deferred maintenance issues, top-of-the-line amenities as well as professional management. They’re located in the most desirable areas with high potential for appreciation with
Class A properties command high rents and experience low vacancies.
These properties are generally 15-20 years old, are typically well-maintained, exhibit a mix of tenant profiles, and may or may not be professionally managed. These properties are located in desirable but not premium locations and may come with some deferred maintenance issues at acquisition.
Class C properties are typically more than 20 years old, located in less than desirable locations, and need significant renovations for repositioning to achieve steady cash flows.
Class D properties are old, run-down, need significant repairs, experience high vacancies, and low appreciation, and are located in distressed communities with high crime and poor schools. Tenants have low income, bad credit, and many have criminal backgrounds. As a result, these properties are cheap to acquire.
Pick Your Financing Structure.
Besides offering investors a variety of investment strategies and property types, passive CRE investments also afford investors the choice of financing structure offering a mix of debt, equity, or hybrid securities.
The variety of financing structures offer investors multiple investment options that can align with various investment strategies, risk tolerances, target returns, timeline, etc.
Common financing structures include:
- Preferred Equity
- Secured Debt
- Debt with Equity Kicker
- Convertible Debt
Something For Everyone.
Commercial real estate investments – especially passive opportunities – offer investors a menu of investment strategies, property types, and financing structures to fit a variety of risk tolerances, desired returns, and exit strategies. Conservative investors seeking consistent, reliable cash flow should consider Class A Core properties. In contrast, the investor with a penchant for risk with patience may consider the upside potential of Class C Value-Add properties.
Management Is Key.
No matter the investment strategy, property type, or financing structure, without knowledgeable, skilled, and experienced management behind the investment opportunity, you might as well buy a lottery ticket. This is because no matter the property’s quality or the strategy’s soundness, incompetent management will derail any opportunity.
In analyzing a potential investment opportunity, besides evaluating the target property and investment strategy to align with your objectives, don’t forget your due diligence on the decision-makers. Ensure management possesses the right combination of skills, experience, infrastructure, personnel, and processes to ensure the success of the proposed venture.