Commercial Real Estate Investing Strategy Guide: Location & Diversify
08 11 2017
It comes as no surprise that commercial real estate is a popular alternative investment in the eyes of investors and financial advisors. Typically, real estate investments have a low correlation to stocks and bonds, and are generally less liquid than other investments common within a portfolio.
You should still always consult a financial advisor who knows your situation – having someone in your corner to help you determine your own strategy is key. With that said, we wanted to take some time to discuss the importance of two investing strategies: Location and Diversifying.
The Importance of Location
Location is always an important consideration when it comes to investing in real estate. Just like commercial real estate trends differently within different markets, the trends within various CRE sectors play an impact as well. It’s always wise to consider the location of any real estate opportunities you may come across.
For example, in many larger metropolitan markets over the past couple years, the demand for office space has risen in urban centers, while suburban office rentals have generally dipped. In some cases, the only difference between two properties is a few miles – but the difference in interest is stark. Meanwhile, certain locations continue to outperform others for years.
Understanding the market in a specific location can help you determine the future impacts should you make an investment in a commercial property in the area.
The Importance of Diversifying
Commercial real estate investing can be broken out into four different strategies that are categorized based on their risk and return profile. These investment tactics are often defined as Core, Core Plus, Value Add, and Opportunistic. Each investment strategy is different as they each hold a different portion of potential risks and returns.
While these are a few available options within the commercial real estate investing market, whether one (or none) fits your situation is a determination you will need to make through your own research and due diligence.
1. Core Investments
While Core investments are considered lower risk investments, they also have the lowest expected return. These are typically fully stabilized properties with long term leases given to credit-quality tenants in primary and secondary markets. These properties are generally Class A buildings and require little refurbishing. While Core investments do not experience significant appreciation in value, they are associated with stable, predictable cash flow and lower risk.
2. Core Plus Investments
Core Plus investments have low to moderate risk with slightly higher (historic) returns than Core. In many ways, Core Plus real estate is like Core; however, the quality of the properties is not as high. Properties may be in the suburbs, the tenant may not be as creditworthy, or the properties may not have rent guarantees from high-quality national companies. Meanwhile, the property type may be riskier than one of the big four sectors, such as self-storage, entertainment, medical offices, or student housing. As a piece of an investment strategy, Core Plus additions tend to have higher risk and return compared to Core investments.
3. Value Add Investments
Value Add investors are usually searching for the opportunity to increase the value of their commercial real estate investments. Value-added investments are typically moderate to high risk and usually have historically higher returns than either Core or Core Plus investments. Investors often target properties where they can make improvements or re-purpose the property then resell. Improvements can have a range of impacts: higher rent, improved management, increasing customer satisfaction, or lowering certain expenses. It’s good to keep in mind that these projects allow more risk because at the time of acquisition, the property is not operating at its full potential—often because it is not fully leased, is leased at below-market rents, has not been properly maintained, or is poorly managed. While the potential returns with a Value Add are higher, so are the risks in case the execution of the investor’s strategy does not go as planned.
4. Opportunistic Investments
Opportunistic investments are similar to the Value Add approach, but riskier; they offer the highest level of risk along with the highest expected return to investors. Usually, these are highly distressed properties, properties in emerging markets, or new development projects which take quite a bit of revamping to be able to capitalize on their full potential. Typically, these assets will be fully vacant at the time of acquisition or the operator will seek to develop raw land from the ground up. If the business plan is successful, these types of projects offer the highest level of return, but they are risky as the properties have little to no cash in place at the time of acquisition and typically have the most complicated business plans.
Determining Your Own Investment Strategy
With commercial real estate investing, maintaining a diverse portfolio is generally recommended. Similarly, the location of a commercial property can have a large impact on one’s overall strategy and portfolio. Some of these strategies may fit your preferences with regards to the timelines, risk levels, and expected returns – but that depends on your experience and the decisions you make with your financial advisor.
Weighing the options is your responsibility, but fortunately, when it comes to real estate investing, there’s plenty of options out there.
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