Quick Take: A value-add real estate investment refers to a property that requires operational improvements, renovations or repositioning in order to increase its value and income potential. These investments typically involve properties that are underperforming relative to their market but have strong fundamentals that can be improved through active management. Value-add strategies generally offer higher return potential than core or core plus real estate investments but involve greater operational risk.
Understanding value-add real estate investments
Real estate investments are often categorized according to their risk and return profile. Within this framework, value-add real estate investments fall in the middle-to-higher range of the real estate investment spectrum.
Unlike core or core plus investments, which focus on stabilized properties, value-add strategies involve properties that require meaningful improvements or operational changes in order to reach their full potential.
These improvements may include renovations, lease-up strategies, improved property management or repositioning within the market. By executing these improvements successfully, investors may increase both rental income and the property’s long-term value.
For a broader explanation of the strategy spectrum, see our guide to core, core plus, value-add and opportunistic real estate investments.
Key characteristics of value-add real estate investments
Value-add real estate investments typically share several defining features:
• Properties that are underperforming relative to their market
• Opportunities for renovations or property upgrades
• Potential for improved leasing or rent growth
• Active asset management and operational improvements
• A clear strategy to increase property value over time
Because these investments require operational improvements, value-add strategies typically involve greater complexity and active management than core or core plus investments.
For example, an apartment community with outdated interiors, below-market rents or operational inefficiencies may represent a value-add opportunity if renovations or management improvements could significantly increase rental income.
Risk and return profile of value-add real estate investments
Value-add real estate investments generally involve higher risk and higher return potential than core or core plus strategies.
Because these properties require improvements or operational changes, the investment outcome depends on the successful execution of the value creation plan.
Returns from value-add real estate investments are typically driven by:
• property renovations or capital improvements
• operational efficiencies
• lease-up strategies or tenant repositioning
• increased rental income and property appreciation
For many investors, value-add strategies offer the potential for greater appreciation while still benefiting from existing income during the improvement period.
Value-add real estate vs other investment strategies
Value-add real estate investments sit between core plus and opportunistic strategies on the real estate investment risk spectrum.
| Real estate investment strategy | Risk level | Income stability | Value creation |
|---|
| Core real estate | Low | High | Limited |
| Core plus real estate | Moderate | High | Incremental improvements |
| Value-add real estate | Higher | Moderate | Significant operational improvements |
| Opportunistic real estate | Highest | Variable | Development or major repositioning |
Investors often compare value-add investments with other strategies across the spectrum.
You can learn more about these strategies in the following guides:
• What is a core real estate investment
• What is a core plus real estate investment
• What is an opportunistic real estate investment
What makes a good value-add real estate investment?
Origin Principal David Scherer explains the five pillars of a value-add real estate investment and who should consider investing in them. Value-add assets need extensive capital investment, but carry great growth potential when executed properly.
1) Location
Value-add assets should be located in cities and submarkets with strong liquidity. They should be located near or within areas of strong growth where investors can make a quick exit when necessary.
2) Vintage
Value-add assets have flexibility when it comes to vintage. Older buildings with strong bones can be brought up to compete with new construction through extensive capital injection, which is the trademark of value-add investments. However, generally, a value-add building will be less than 30 years old.
3) Cash Flow
A value-add asset should achieve its maximum cashflow around four to five years after initial improvements have been initiated. Investors shouldn’t expect strong dividends in years one and two, as the property will be undergoing large-scale renovations during this time.
4) Debt to Equity
A value-add asset can be anywhere from 60-75% leveraged.
5) Expected Returns
Returns are dependent on larger market trends but, generally, a return between 11-15% should be expected with value-add investments.
Who Should Invest in Value-Add Real Estate?
Investors who tend towards growth stocks when looking at the public markets should consider investing in value-add real estate. Value-add real estate investing requires a tolerance for moderate risk, but the potential returns justifies any increase in overall investment risk.
How value-add real estate investments fit into a portfolio
Value-add real estate investments are often used by investors seeking higher appreciation potential within a diversified real estate portfolio.
Because these strategies involve improving underperforming properties, they offer opportunities to increase property value through active management and operational execution.
Many investors combine value-add investments with both core or core plus assets for stability and opportunistic investments for higher-risk opportunities, creating a diversified approach across multiple real estate strategies.
There is a private real estate investment strategy for virtually every investor.
Key Takeaways
- A value-add real estate investment involves improving a property to increase income and overall value.
- These investments typically require renovations, operational improvements or repositioning.
- Value-add strategies generally involve higher risk than core or core plus investments.
- Investors often pursue value-add opportunities to capture greater appreciation potential.
FAQs
What is a value-add real estate investment?
A value-add real estate investment refers to a property that requires improvements or operational changes in order to increase its income potential and market value.
What types of properties are considered value-add real estate?
Value-add investments may include multifamily, office, retail or industrial properties that require renovations, lease-up strategies or operational improvements.
How is value-add different from core plus real estate?
Core plus investments involve modest improvements to stabilized properties, while value-add strategies typically require more significant renovations or repositioning.
Are value-add real estate investments risky?
Value-add investments generally involve higher risk because the investment outcome depends on successfully executing renovations, leasing strategies or operational improvements.
Why do investors pursue value-add real estate?
Investors pursue value-add real estate opportunities because improving underperforming properties may create meaningful appreciation and increased rental income.
