June 27, 2021

An Overview of Core, Core Plus, Value-Add and Opportunistic Investments

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By

Eric Wilson

An Overview of Core, Core Plus, Value-Add and Opportunistic Investments

If you spend any time around commercial real estate, you’re bound to hear the terms core, core plus, value-add and opportunistic real estate thrown around. These terms are used to define the level of risk and return potential of an investment property. Not only are the physical attributes of the property used to define an investment but the amount of debt financing to support the project is also imperative.

To explain why the debt financing has such an important role, I find it easy to understand if you look at a single-family property. If a property has a long-term lease in place, it can sound attractive to a conservative investor who wants to play it safe. However, if the same property has been primarily financed through debt with very little equity, it can paint a very different picture. Should the property value decrease, the owner could end up owing more on the property than it’s worth.

As a commercial real estate investor, you should know about each of these terms. Let us take you through them one by one to help you understand them better.

Core Real Estate Investments

Core Real Estate is one of the safest investments in the market. These are ideal for investors that fall in the conservative category and want a stable income. Given the low risk of these properties, the income generated through them is also low.

One great thing about these properties is that they require little attention. You don’t have to be actively involved in the ownership and the tenants that occupy the property are usually long-term leases.

The return on core real estate investment falls between 7% to 10% and to finance this transaction, 40% to 45% debt can be used. The return on these properties is a result of cash flow from occupancy rather than appreciation.

If a core investment is leveraged to 80%, it loses its safety net and can affect its value. If there’s a decrease in the property’s value by even 10%, it could lead to default and foreclosure.

Core plus Real Estate Investments

These properties are for investors that have a low to moderate risk profile. Growth and income can be generated through small improvements such as high-credit tenants, some upgrades here and there as well as improved management.

Much like core properties, core plus real estate is often high quality and located in some of the best areas of a city.

Even though the risk is moderate in a core plus real estate investment, there are some drawbacks such as an unpredictable cash flow, that come with it. One way to deal with it is to actively participate in making it better and not delay improvements. Operational efficiency becomes increasingly important here.

The leverage used by core plus investors is 45% to 60% of the property value and the annual return they can expect to earn is 8% to 10%

Value-Add Real Estate Investments

There are properties out there that are in excellent condition and are considered extremely lucrative in their current condition. Value-add real estate is not. You guessed it, the very name suggests that we need to add value to make this property lucrative.  

Value-add real estate is also known as growth investments due to their ability to increase in value. For those who are willing to take moderate to high-risk, this is an excellent option.

When you attain a value-add project, it may generate little or no cash flow in the beginning for a variety of reasons. Poor management, tenancy issues and outdated facilities are the usual suspects. However, once you start to put in the effort and improve it, you will find that it can produce a steady and handsome return.

Properties that fall in this category can have a lot of issues such as occupancy problems, ineffective management and delayed maintenance. If you’re interested in investing in one, you will have to have extensive knowledge about the market and be involved in strategic planning. In addition, you should also be able to spot operational oversights by their owners and come up with an effective way to solve those issues.

Around 60%to 75% leverage is used by value-add investors to generate returns of about 11%to 15%. Of course, there are risks associated with value-add real estate but with the help of an experienced management team, you can reduce them.

Opportunistic Real Estate Investments

Of all the investments we have discussed, this is the riskiest. Even though it has potential of growth much like the value-add real estate, these properties happen to be much more complicated. In fact, it’s not uncommon for investors to not see any returns for the first 3 to 4 years.

When you acquire an opportunistic property, there may be no cash flow in the beginning but there is potential of generating a large income once value has been added. The leverage used by opportunistic investors is typically 70% or more but it varies significantly at this level. If there is land development involved, investors will find it very difficult to get a loan that finances more than 50% of the property. Once the property starts making money, the investors can typically expect a return of 20% or more, annually.

There are always exceptions when generalizing an asset especially one as involved as commercial real estate. Knowing the difference between different types of properties available to you can help you find a strategy that fits your profile, then you can do your due diligence to make informed decisions. Your strategy depends on how much risk you are willing to take and what your objective is. If you are a conservative investor, you should ideally opt for high quality properties with low leverage. If you have a long-term vision in mind, value-add real estate maybe best for you.

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