The beauty of commercial real estate is that there is an investment strategy for investors of every risk tolerance.
Commercial real estate investment strategies fall into one of four segments according to risk, quality, and potential return:
CORE: Low Risk (7-11% Historic Annual Returns)
Core investments are typically low-risk and require no improvements or active management. It’s as close to a turn-key investment as you can get in the CRE world.
Along with the low risk, they also offer lower returns than the other investment types. These properties generate stable, consistent cash flow from established, high-quality tenants locked in with long-term leases.
For example, a national drug store with a 30-year lease would be considered a core property. Core properties require little to no maintenance, with most under NNN or NN arrangements. The majority of expected return is generated mostly from cash flow as opposed to appreciation.
CORE PLUS: Low to Moderate Risk (8-12% Historic Annual Returns)
Unlike Core properties, Core Plus properties offer the ability to improve cash flow through slight property or management improvements or by improving the tenant profile.
Core Plus properties tend to be of high-quality and well-occupied from the get-go.
Unlike Core properties that are occupied by long-term, established tenants, Core Plus cash flow is less predictable with more diverse tenants and these properties require active management by ownership.
A 10-year-old apartment building with a good track record or occupancy and quality of tenants in need of light upgrades is an example of a Core Plus investment opportunity.
Core Plus properties will generate higher rates of cash flow than Core properties but some of that cash will be needed for deferred maintenance. And unlike Core properties, a higher portion of the property’s expected return will be generated from appreciation because of the property improvements.
VALUE-ADD: Moderate to High Risk (10 to 15% Historic Returns)
Value-add properties when acquired underperform in terms of cash flow and occupancy but have the potential to see big bumps in occupancy and rents and as a result, cash flow, once a value has been added.
At acquisition, most of these value-add properties have occupancy issues, management problems, infrastructure and maintenance problems, or a combination of all three.
These investments require real estate expertise, strategic planning, and active management. Total expected returns are generated both from cash flow and appreciation.
OPPORTUNISTIC: High Risk (12%+ Historic Returns)
Opportunistic investments are the riskiest of all types of CRE investment strategies. Opportunistic properties involve the most complicated projects like ground-up developments, land development, of repositioning a building from one use to another.
Opportunistic investments typically involve dealing with entitlement, zoning, and rezoning issues that can last for years. As a result, investors may not see a return on their investment for three or more years.
One Size Does Not Fit All
Commercial real estate offers investment strategies for investors of all risk tolerances and time frames.
For investors seeking low-risk investments and immediate cash flow, Core properties would suit their strategy.
For investors with a long-term investment window with a high-risk tolerance seeking big potential payoffs, opportunistic properties may be ideal.
Management Is Key
At FTW Investments, we believe that management holds the key to investment success no matter the strategy.
Incompetent management can wreck a relatively low-risk Core opportunity while highly skilled management with substantial experience can turn moderate to high-risk opportunities into relatively low-risk ventures that preserve the potential for high returns.
With the right infrastructure, personnel, and processes in place, the right managers can turn any opportunity into gold.
With Core and Core-Plus properties, the key is to know when to push and when to stand back in order to maximize ROI without increasing risk or costs due to mismanagement.
On the other end of the risk spectrum, here at FTW Investments, we relish the opportunity to generate Value-Add and Opportunistic level returns at Core-level risk levels with the right strategies.
We believe that with strategic improvements, value-add and opportunistic-level properties can be turned into cash cows with minimal risk. It all starts with incorporating the right mix of value-adds that will increase cash flow and long-term appreciation without overspending or overexertion.
Strategies we incorporate for increasing cash flow include increasing revenue, decreasing expenses, or a combination of both.
Here are some typical strategies we incorporate into our acquisitions:
- Adjust rents to match market rates.
- Add amenities and capital improvements.
- Improve screening to acquire higher quality tenants.
- Make cosmetic improvements to enhance curb appeal.
- Improve marketing.
- Improve management and property management for more efficient and cost-effective operations.
No matter your risk tolerance, investment time frame, or property preference, there is an investment strategy sure to meet your needs.
In weighing your different investment strategies and options, don’t make decisions based on risk-return alone.
Make sure management possesses the right combination of skills, experience, personnel, and processes in order to execute the desired strategy.
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