Acquiring a commercial property takes careful thought and development strategy, especially if you are looking to mitigate risk and maximize your return on investment. The condition of a property, its location, lease terms, and tenants all come together to determine the overall success of a property as an investment.
A core investment is considered the safest form of property investment because a typical property of this type is high quality, has a great location, involves low risk and has a steady, predictable return. An example could be a class A office building in New York City. The property most likely has little to no vacancy due to its location and high demand within the marketplace. Core properties also include credit tenants who will likely enter into long-term leases and generate a steady income stream for landlords. Core investments can also prove to be very resilient and withstand economic hardships. Anyone looking to create a new source of passive income over a long period of time could acquire a core investment because they are the most stable property type, similar to a bond.
Core Plus properties involve a moderate amount of risk, while also providing a moderate return. Their location could also be as good as a core property, but might have an expiring lease or some other factor that increases the risk and return. An example is a cash flowing asset that requires some minor tweaking to increase net operating income (NOI). Investors will acquire a property for less than what a core investment would have cost, then make small renovations, cosmetic improvements, and other adjustments to the property to increase their return. Core plus properties could also come with tenants that have a lower credit rating than tenants in a core property. Tenants could be less stable, less reliable, and might not lease the property as long as they would with a core investment. There could also be a bit more vacancy due to the building being older or the location being less desirable. Core plus investing is more sensitive to market cycles and will slow down when markets cool.
Value-add investments involve an even higher risk than core plus, but are considered to have a medium to high return if executed properly. Buyers who acquire these properties are generally more experienced in commercial real estate investments and understand the amount of risk involved. An example of a value-add property is a dated apartment complex with deferred maintenance and requires a complete renovation. These types of investments will not see any return on investment for a long period of time due to the amount of capital that will have to go into fixing them up and the amount of time required to execute the strategy. Leasing is often a critical part of the overall strategy to start generating income, as value-add properties typically have a higher vacancy rate upon acquisition. The price is dropped on value-add properties due to the risk associated with the cost of renovating and leasing the property back to stabilization. The overall goal is to create a profitable investment by modernizing the building and bringing it up to market standards and ADA code. Once a value-add property has been updated, filled its vacancy, and is generating a steady NOI, it might be resold as a core investment property.
Opportunistic properties are defined as having the highest risk and reward. These types of properties require a significant amount of redevelopment and usually come with the highest vacancy level compared to other investment properties. Investors who choose opportunistic properties are focused on the bigger picture and understand they won’t see a return on investment in the immediate future. Construction is often required with opportunistic properties, including major renovations involving tearing down all or parts of a structure, gutting a building, or even ground up development. It’s not uncommon for investors to tear down the structure completely and start constructing a new property type. These properties take time to come together because they are in the poorest condition, generating the least cash flow upon acquisition. Investors know they will have to wait the longest to see a positive return. Overall, opportunistic properties are best left to experienced investors who know they will need to put a significant amount of effort into these projects to be able to see a return in the far future.
Being educated on the four main types of property investments will increase your chances of seeing a positive return on your investment. We have years of experience in acquiring, redeveloping, and selling commercial properties using various strategies. Many of our clients for the net lease properties we develop often utilize the 1031 exchange deferred tax strategy.
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JEFF CARPENTER >
As a Partner at SimonCRE, Jeff Carpenter is responsible for sourcing opportunities in both ground up development and through the acquisition of value add assets. Jeff has successfully completed projects across the country and has been an integral part of the exponential growth SimonCRE has experienced since he joined.