There are several real estate investment strategies that are differentiated by their risk-to-return characteristics. As the risk profile of each strategy is based on the amount of leverage used to acquire the asset and the characteristics of the asset such as tenant credit worthiness, length of the lease, location, and physical condition of the asset. A higher leveraged asset will increase investment returns and, all things being equal, a higher leveraged asset will also increase the risk associated with the asset due to increased likelihood of a default and foreclosure if the asset value declines during a market cycle downturn. There are four main types of strategies:
Core
Core Plus
Value-Add
Opportunistic
The Core Strategy has the lowest risk of all the real estate strategies. Core real estate assets are located in the high demand areas of major cities like Los Angeles and New York. Core assets are typically on long-term leases and tied to "credit tenants," which have been deemed by a major credit agency (like Moody's or Standard and Poor's) to have the financial strength of being rated as investment grade. These assets generate consistent cash flow, and their values tend to be the least volatile of all real estate assets. For instance, a core asset would be a CVS or Walgreens store on a long-term lease.
The Core Plus Strategy has a higher return than Core but with a slightly higher risk profile. Core Plus real estate assets are similar to the ones found in Core, but the quality is not as high. These assets may be in secondary markets or asset types, such as medical offices and student housing. These assets generate less predictable cash flow than Core assets but it may be possible to increase the cash flow by improving the property, quality of tenant, or the management.
The Value-Add Strategy has a higher return and a slightly higher risk profile than Core Plus. The higher risk profile is, for the most part, due to the use of higher leverage of up to 80%. Value-add assets may be in safer primary markets or riskier secondary markets. These assets may suffer from one or more deficiencies, such as poor management, deferred maintenance, and occupancy issues that will be addressed as part of the value-add strategy. There is the potential to greatly improve upon the existing amount of cash flow of these assets once the value-add strategy has been implemented.
The Opportunistic Strategy has the highest risk of all the real estate strategies. Opportunistic assets involve the most complicated real estate projects. These opportunities may include repositioning an asset from one use type to another, renovating a highly distressed property, or developing raw land into residential or commercial properties. Investors in these deals may not obtain a return on their investments for several years, but the resulting cash flow may be very high.
The Value-Add investment strategy has a very favorable risk-to-reward profile when properly implemented on assets that have in-place cash flow with potential for forced appreciation. It should be noted that this strategy becomes more difficult to apply in the latter stages of the real estate cycle when price valuations reach "premium" levels.
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