Individuals who are buying stocks or mutual funds often look to descriptive labels – growth, income and value – to quickly understand the scope of that investment. Private equity real estate funds also are separated into distinct categories that make it easier for investors to understand the strategy, objectives, risk level and target returns.
- Core Plus
- Value-Add; and
Those strategies lay out much like a set of stairs on the risk spectrum. Each forward step assumes more risk, and ideally, a bigger return. Core is on the bottom with the lowest risk, followed by Core Plus, Value-Add and Opportunistic sitting at the top as the most aggressive, highest risk category.
Core Investing Strategies:
One word commonly used to describe the core investing approach is stable. Core commercial real estate assets are top tier, best-in-class properties. Some well-known examples include the Waldorf Astoria hotel in New York City or the Wilshire Grand Center in Los Angeles. However, smaller cities across the country, such as Austin, Denver and Nashville, are all home core properties across sectors that include Class A office towers, shopping malls, high-rise apartment buildings, hotels and industrial facilities.
Pros & Cons: Private equity real estate funds that follow a core investing strategy tend to offer stable, steady returns and stable values. One downside is that core assets are usually fully priced, meaning that there is less upside for value creation.
- Demand: High occupancies with a strong base of good credit tenants.
- Structure: Quality design and construction with modern features and amenities.
- Location: Tier I or Tier II cities, as well as a premier location within a market or trade area.
Core Plus Investing Strategies:
Core-plus assets share many of the same characteristics as core assets. However, there are one or two exceptions, or perhaps a specific issue, that pushes it out of the core category. For example, an office tower might have a best-in-class location, but it may need a minor renovation or updates so that it can better compete with its peers.
Pros & Cons: Private equity real estate funds that follow a core-plus strategy typically offer greater upside in income growth and value appreciation compared to core. Core plus investing also may require more time to make changes before investors start seeing the added benefit of improvements. In some cases, there is the potential to elevate a core plus asset to core status.
- Shares many of the same characteristics as a core asset.
- Offers slightly more risk compared to core investing.
Value-Add Investing Strategies:
Much like the name suggests, the key to this investing approach is “value” in that investors are buying a property at a discount to current market prices with a plan to implement a strategy to “add” value. Value-add assets often have a bigger problem that needs fixing, such as more extensive renovations, capital improvements or re-tenanting. Properties also can add density through an expansion or new development on the property. There are many value-add investment opportunities to be found in the inventory of aging or under-utilized properties across the U.S. One example is investors that are acquiring aging apartment buildings and investing additional capital to renovate units and common areas that allow them to raise rents.
Pros & Cons: Private equity real estate funds that follow a value-add investing approach hope to achieve higher target returns, primarily through value appreciation. This investment strategy requires added time, capital and expertise to successfully execute a business plan and achieve desired results, and investors are assuming moderate to high risk levels.
- Properties usually have a problem to fix, such as a major vacancy or functional obsolescence.
- Investment opportunities can be found broadly in a variety of urban, suburban and even smaller cities.
Opportunistic Investing Strategies:
Opportunistic investment strategies involve highly complex and speculative projects. There are a variety of different scenarios that fall into this category, including new development, redevelopment, adaptive reuse ore repositioning of distressed or vacant properties. Some examples are investors who convert an old warehouse to luxury residential lofts or transform a vacant mall into a new mixed-use destination.
Pros & cons: Opportunistic investments come with big risks, and potentially, very big returns.
- Opportunistic projects can be highly speculative.
- Specialized expertise may be required to execute plans successfully.
- Investors may need to be patient. Some projects may take several years to complete.
Understanding core, core plus, value-add and opportunistic strategies gives investors guidance on the risks and target returns. Investors often choose an investing approach that best fits their own risk tolerance. Investors also can choose to invest in private equity real estate funds that follower different investing approaches to create a diversified real estate investment portfolio.