Commercial real estate investments typically fall into one of four baskets – Core, Core-Plus, Value-Add, and Opportunistic. Each is differentiated by their levels of risk vs. reward with Core real estate investments on the low end and Opportunistic real estate investments on the high end of the risk-reward spectrum.
Ideally, as a real estate investor, you would prefer an investment that was both low risk and high reward, but so-called experts would tell you that’s not possible. We beg to differ. We believe that value-add investments, if done right, offer the highest rewards for the lowest risks.
You hear all the time about alternative investments offering high risk-adjusted investments compared to Wall Street offerings. Among the classes of CRE investments, we believe value-add investments provide the best risk-adjusted returns. We’ll explain why, but first, a primer on the four types of investments.
Core (7-10% annual return). 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 investments generate between a 7% and 10% annualized return.
Core Plus (9-13% annual return). Core Plus investments are low to moderate risk. 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 with 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.
Core Plus investors can expect to achieve returns between 9% and 13% annually.
Value-Add (13%-18% annual return). Value-add investments are considered moderate to high risk. Value-add properties 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. Investors can expect annual returns between 13% and 18%.
Opportunistic (>20% annual return). 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, or repositioning a building from one use to another.
Opportunistic opportunities 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. Opportunistic properties have the potential to generate annual returns of over 20%.
Here at Hickory Creek, we believe value-add opportunities are the Goldilocks of CRE investment opportunities because they have the potential to generate immediate and boosted cash flow with a bump in appreciation from our value-add efforts.
Although considered moderate to high risk, we believe risk can be minimized with the right analysis, in-place infrastructure, and skilled management.
That is why we love value-add opportunities in the multifamily segment.
We seek out multifamily opportunities in under-supplied locales, and with our proprietary analysis, established infrastructure, and expert management, we can increase cash flow and appreciation while minimizing risk in a high-demand CRE segment of multifamily properties.
We believe that with strategic improvements, value-add multifamily properties can offer the best returns with minimal risk.
It all starts with making the value-adds that will increase cash flow, which will increase long-term appreciation. Strategies for improving 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
Value-add multifamily properties allow experienced investors to leverage their knowledge, infrastructure, and expertise to increase cash flow and appreciation to generate the best risk-adjusted returns of all CRE investment types.
With the right strategies, investors can generate Opportunistic investment level returns with Core investment levels of low risk. That’s why we like value-add multifamily investment opportunities.
Invest for Success,