Understanding core, core plus, value-add and opportunistic investment strategies can help you predict the potential risk and return profiles for most commercial real estate (CRE) asset and fund offerings.
The risk-return profiles for the four CRE investment strategies discussed in this article can vary in definition depending on the source you’re getting them from. In your research, you may find that each industry expert, institution, or source may have their own interpretation of each strategy.
With that in mind, this article reflects how Caliber defines them. We’ll help you visualize each strategy, using simple commercial real estate investing scenarios to paint you a clear picture of the potential risk and reward profiles for each strategy.
After reading the article, you can review our assets page to see how we apply these strategies in our investment ethos to generate wealth for our investors.
The Differences Between Core, Core Plus, Value-Add and Opportunistic Strategies Using Simplified Examples
Core Investment Risk-Return Profile
The goal of Core strategies is to focus on investing in assets that are producing income and need little to no renovations. Investments are typically made in Class A/B assets with long-term leases, desirable areas and low vacancy rates. This strategy usually attracts older and/or more conservative investors seeking to generate predictable income and potentially earn modest investment gains.
Imagine investing in a modern, 150-unit multi-family apartment community that hardly needs any maintenance updates as it’s only a few years old and produces income. However, this “A-type” property is in a “B-type” location and is overseen by “F-level” management. Poor management is the reason why the assets are for sale.
Knowledgeable fund sponsors and investors are typically quick to scoop a parcel up like this because it’s an income-producing property in a trending location with very little, to no renovations. Additionally, the previous owners of the property typically have debt that can be leveraged by the new ownership. This can help decrease the sale price for the asset and/or create additional liquid capital for the investing parties when leverage is employed.
Core Plus Risk-Return Profile
Core plus strategies invest in properties that are very similar to core properties, but, for one reason or another, they don’t quite fit into the most conservative category.
They are typically income-producing properties that are well leased—maybe not leased to the absolute highest quality tenants, as you would expect with a core asset, However, the tenant base is still creditworthy and there is likely a history of leasing the property successfully. Most core plus assets are stable, meaning they don’t require the buyer to complete extensive renovations or figure out a way to get from 50% occupied to 95% occupied.
Consider, for example, an asset in a Class A location—perhaps right in the middle of a city’s bustling downtown district. If the building itself is Class A, then this would be a core asset, but if it is Class C—maybe a tired 1970s apartment building—it will land in the core plus category.
Leverage is another reason an asset could move into the core plus category. Suppose you have a Class A location and a Class A building considered a core asset, but you’re leaning on more debt than typically seen in a core strategy, then the asset will move into the core plus category due to the higher risk profile.
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Value-Add Risk-Return Profile
Value-add strategies find properties priced below the market that needs some work to restore their value. In many cases, an attractive property for the value-add category features strong fundamentals that need changes to restore cash flow. Commonly, value-add properties have little to no cash flow at acquisition.
For instance, imagine a 200-unit multi-family apartment complex that is in an up-and-coming neighborhood. The property has seen better days and needs some renovations to restore it to its former glory. This particular asset may have significant vacancies upon purchase due to a lack of modern amenities or poor tenant relations—all of which can be addressed relatively easily. These types of assets can generate significant returns if appropriately managed as the cost of renovations is typically much lower than their potential increase in value.
Value-add strategies appeal to investors who seek higher returns and understand that a greater risk could lead to better rewards down the line. Additionally, with the right team in place, these types of assets can provide a long-term income stream through rent payments.
You can use this strategy to purchase distressed properties that are in need of repair and improvement, then renovate them for re-lease or sale. Through careful research and analysis, value-add investments can be managed profitably and develop into quality projects with robust returns.
Opportunistic Risk-Return Profile
Opportunistic strategies include:
- Developing something from scratch (ground-up development).
- Repurposing a building from one use to another (adaptive reuse).
- Winning entitlements for raw land.
For these risks, it’s reasonable to potentially receive 20% annualized returns or more by investing in a successful opportunistic project. However, the multiples may fluctuate depending on the length of time of the holding period.
Ground-up development is a type of real estate project that involves the entire development process from concept to completion for land that has not yet been developed or improved. Although this strategy may come with significant risks, it may also offer a substantial return on investment.
Adaptive reuse involves taking ownership of an existing building or structure and repurposing it for a different use, for example, converting office space to residential or retail use. While adaptive reuse may be more cost-effective than ground-up development, the risks are potentially higher in this scenario since the existing infrastructure may need further work to bring it up to code or modern standards.
Entitlements, the process of obtaining zoning variances and permits from state and local agencies, are required for any real estate development project. While this process can be complex and time-consuming, it’s necessary to ensure regulatory compliance is adhered to. Entitlements may also provide an opportunity to negotiate additional benefits from municipalities in exchange for certain investments or agreed-upon conditions.
Overall, each of these real estate strategies offers potential rewards for investors, but it’s important to be aware of the risks and challenges that come with each approach.
Regardless of the Risk-Return Profile strategy you decide to pursue…
…between core, core plus, value-add and opportunistic offerings; recognizing market fundamentals, establishing a solid team of professionals, and understanding all aspects of the assets you’re interested in investing in are key to success. With the right strategy in place and a focus on execution, you can find success no matter what strategy you choose.
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Caliber is a leading vertically integrated asset management firm whose primary goal is to enhance the wealth of investors seeking to make investments in middle-market assets. We strive to build wealth for our investor clients by creating, managing and servicing proprietary products, including middle-market investment funds, private syndications, and direct investments. Our funds include investment vehicles focused primarily on real estate, private equity, and debt facilities. We market our services through direct sales to private investors, wholesaling to investment advisers, direct sales to family offices and institutions, and in-house client services. Caliber’s middle-market specialty allows the Company to compete with agility and speed in an evolving arena of alternative investments. Additional information can be found at Caliberco.com and CaliberFunds.co.
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If you would like to speak to someone about diversifying your retirement accounts, contact us at [email protected] or call (480) 295-7600 to schedule a call with a member of our Wealth Development Team.
If you would like to learn more about Opportunity Zone Investing, Caliber has put together a special guide that cuts through the myths and misconceptions and outlines the benefits, the risks, and the upcoming deadlines you must know to be able to participate. Get access to the guide here.
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