Quick Take: Core, Core Plus, Value-Add and Opportunistic are terms used to define the risk and return characteristics of a real estate investment. They range from conservative to aggressive and are defined by both the physical attributes of the property and the amount of debt used to capitalize a project.
Physical attributes of assets can include length and term of the in-place leases, credit worthiness of the tenants, and the physical condition and location of the building. The amount of debt used to capitalize a project is an equally important consideration because it impacts the risk profile of the investment. For example, a property with a credit tenant and long-term lease in place may be attractive to the conservative investor, but not when 80% of the purchase price is financed with debt.
Core Real Estate Investments
‘Core’ is synonymous with ‘income’ in the stock market. Core property investors are conservative investors looking to generate stable income with very low risk. Core properties require very little hand-holding by their owners and are typically acquired and held as an alternative to bonds. This type of investing is as close as one can get to passive investing when buying properties directly. A core property requires very little asset management and is typically occupied with credit tenants on long-term leases.
These properties generate stable and consistent cash flow to their owners and their values tend to be the least volatile. For example, a Walgreens drug store with a 30-year lease would be considered a core property, as would a large, fully leased office building in Manhattan with little to no deferred maintenance.
Core investors expect to achieve between a 7% and 10% annualized return and use 40%-45% debt to capitalize a transaction. The majority of the expected return is likely to be generated through cash flow from the property rather than appreciation.
Again, it’s important to keep in mind both the physical characteristics and the capital structure when determining the investment profile. A core asset leveraged to 80% is no longer a core investment. Higher leverage magnifies returns and all property values fluctuate. A 10% decline in the property’s value could violate the lending terms and lead to a default and foreclosure.
Core Plus Real Estate Investments
‘Core Plus’ is synonymous with ‘growth and income’ in the stock market and is associated with a low to moderate risk profile. Core plus property owners typically have the ability to increase cash flows through light property improvements, management efficiencies or by increasing the quality of the tenants. Similar to core properties, these properties tend to be of high-quality and well-occupied.
The potential downside of a core plus real estate investment is that the cash flow is less predictable than a core investment, and these properties require active participation by ownership. A 15-year-old apartment building that is well-occupied but in need of light upgrades is an example of a core plus investment opportunity. The property will produce ample cash flow but some of the cash will be used for future deferred maintenance such as roofs and parking lot repairs.
Core plus investors tend to use between 45% and 60% leverage and expect to achieve returns between 8% and 10% annually.
Value-Add Real Estate Investments
‘Value-Add’ is synonymous with ‘growth’ in the stock market and is associated with moderate to high risk. Value-add properties often have little to no cash flow at acquisition but have the potential to produce a tremendous amount of cash flow once the value has been added. These building often times have occupancy issues, management problems, deferred maintenance or a combination of all three. These investments require a deep knowledge of real estate, strategic planning, and daily oversight by their owners.
Value-add investors tend to use between 60% and 75% leverage to generate annual returns between 11% and 15%.
Opportunistic Real Estate Investments
Opportunistic is the riskiest of all real estate investment strategies. It is also synonymous with ‘growth’ in the stock market, like ‘value-add,’ but it is even riskier. Opportunistic investors take on the most complicated projects and may not see a return on their investment for three or more years. These investment strategies require years of experience and a team of people to be successful. Ground-up developments, acquiring an empty building, land development and repositioning a building from one use to another are examples of opportunistic investments.
Opportunistic properties often have little to no cash flow at acquisition but have the potential to produce a tremendous amount of cash flow once the value has been added. Opportunistic investors tend to use leverage of 70% or more, but the amount of leverage can vary based on the ability to obtain debt. For land development, banks simply won’t lend more than 50%. Opportunistic investors can expect the highest annual returns for a real estate investment, often over 20%.
Real Estate Risk and Return Spectrum
The four strategies can be viewed along a broader risk and return spectrum. The visual below illustrates how core, core plus, value-add and opportunistic strategies relate to one another within private real estate investing.
Aligning Strategy With Risk Tolerance
It’s important for investors to know the difference of each strategy because the actual risk of an investment and the advertised risk may be very different. A conservative investor focused on income generation should be investing in higher-quality properties with low leverage or in a debt fund that lends money. Those with a bigger appetite for risk and a longer time horizon should consider value-add or even opportunistic strategies. Dialing leverage up or down will reduce or increase the financial risk and the risk profile. Identifying investments that align with an individual investor’s risk and return objectives is an essential part of portfolio construction.
There is a private real estate investment strategy for virtually every investor.
FAQs
How do physical attributes affect risk and return?
Physical attributes such as the length and term of in-place leases, the creditworthiness of tenants, and the physical condition and location of the building can influence an investment’s risk profile. Properties with long-term leases and strong credit tenants are often viewed as more stable, which may appeal to more conservative investors.
How does debt impact risk and return?
The amount of debt used to capitalize a project is an important consideration because it affects the overall risk profile of the investment. For example, a property with a credit tenant and long-term lease in place may be attractive to a conservative investor, but that risk profile can change if 80% of the purchase price is financed with debt.
What is deferred maintenance?
Deferred maintenance is the intentional postponement of required repairs and capital improvements in order to manage budgets, preserve cash flow, or align spending with an investment strategy. While this approach may support short-term financial performance, delaying necessary work can accelerate physical deterioration and increase long-term costs. If prolonged, it can also create operational disruptions and potential health or safety risks.
What Is a Risk Profile?
A risk profile is an evaluation of how willing and able an investor (or organization) is to take on risk. It combines a person’s tolerance for risk with their financial capacity to handle potential losses. In investing, a person’s risk profile helps guide decisions about which types of assets or strategies are most suitable for them, balancing potential gains against possible downside.
What is the highest risk real estate strategy?
Opportunistic strategies typically involve development or major repositioning and are often considered higher risk due to execution and market exposure.
How does value-add differ from core plus?
Core plus usually involves modest improvements to stable properties, while value-add strategies often require more significant renovations or operational changes.
