Investing in real estate can be done in four ways: Core, Core Plus, Value-Add, and Opportunistic. When it comes to the property’s physical qualities and how much debt is used to fund a project, they fall into a range of conservative to aggressive.
In addition to the length and period of the in-place leases, the creditworthiness, physical condition, and location of the building might be considered physical qualities. The quantity of debt taken out to fund a project is also significant because it affects the investment’s risk profile. A property may tempt a careful investor, but not if a debt is used to pay 80% of the purchase price.
Investors need to be aware of the following terms:
- Core Real Estate Investments
In the stock market, “core” is identical to “income.” Core property investors are cautious investors who want to create a consistent income with little risk. Core properties are often acquired and retained as an alternative to bonds and require relatively little hand-holding from their owners. When purchasing homes directly, this is the closest thing to passive investing. A core property needs very little maintenance and is usually rented out to tenants with good credit.
These properties offer their owners solid and constant cash flow and have the least variable values. Core properties include, for example, a Walgreens with a 30-year lease and a vast, fully occupied, and exceptionally well-maintained office building in Manhattan’s Financial District.
Core investors anticipate a 7% to 10% annualized return and a transaction financed with 40-45 percent debt. Most of the predicted return will likely be generated by the property’s cash flow rather than appreciation.
When defining the investment profile, it is critical to consider both the physical qualities and the capital structure. It’s no longer a core asset if leveraged to 80%. Leverage increases returns, and all property values vary. It could break the mortgage if the property’s value declines by 10%. The property could lead to a default and foreclosure.
- Core Plus Real Estate Investments
Growth and income are synonymous with “Core Plus,” which has a low to moderate risk profile in the stock market. It’s common for core plus property owners to increase cash flow by making minor property upgrades, streamlining management processes, and attracting better tenants. These properties, like core properties, are often high-quality and well-occupied.
The cash flow generated by a core plus real estate investment may be less predictable than that caused by a core investment. For example, an apartment building that has been well-occupied for 15 years but needs a few minor alterations is an example of a “core plus investment.” There should be enough cash flow from the property, but others will be used to pay for long-term maintenance like roof and parking lot repairs.
Core plus investors often borrow 45-60% of their investment capital and aim for 8-10% annual returns.
Do you think you fit into two of the four types of real estate investment now that you’ve learned about them? There’s more to it than that! Find out more about the rest by reading the other two types of real estate investment, and you may discover the one that suits you best and yields the most long-term returns.
- Value-Add Real Estate Investments
In the context of the stock market, “value-add” is identical to “growth,” and it is associated with moderate to high levels of risk. At the time of acquisition, value-add assets typically generate very little or no cash flow. Nevertheless, these properties usually have the potential to provide a significant amount of cash flow once the value has been added.
These buildings frequently suffer from problems related to either occupancy, management, deferred upkeep, or a combination of these issues. The owners of these investments need to have an extensive understanding of real estate and the ability to plan strategically and monitor their properties daily.
Value-add investors usually use 60–75% leverage to get 11–15% annual returns.
- Opportunistic Real Estate Investments
The riskiest real estate investment strategy is opportunistic. It’s also a stock market term for “growth,” just like “value add,” although it’s riskier. A return on investment for opportunistic investors may take three years or longer, as they take on the most demanding enterprises. It takes years of skill and a team to succeed in these financial techniques. Opportunistic investments include ground-up developments, acquisition of an empty building, land development, and relocating a property from one use to another.
At the time of acquisition, opportunistic assets frequently have little to no cash flow. Still, they have the potential to provide a significant amount of cash flow after the value is added. The degree of leverage used by opportunistic investors tends to be 70% or more, though this might vary depending on the ability to get financing. Banks will not lend more than half of a project’s total cost for land development. Investors willing to take advantage of Opportunistic Investment can expect returns of up to 20% per year from a real estate investment.
The degree of risk associated with each technique varies, and investors need to recognize this to make informed decisions. Low-leverage investments in high-quality properties are ideal for conservative investors who want to generate income. Those with an enormous appetite for risk and a longer time horizon should consider value-add and opportunistic methods. It is possible to adjust a company’s risk profile and financial vulnerability by varying the leverage used to borrow money. Every individual investor can find a private real estate investing plan that works for them, and identifying investments that match their risk/return profile is critical.
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