Within the private real estate syndication industry, assets are typically grouped into four primary strategies: Core, Core Plus, Value-Add and Opportunistic.
The key differentiator between these categories is the risk and return profile. Moving between these strategies is similar to stepping up a ladder in terms of taking on more risk, and in theory, being compensated for that risk with a higher return.
Our focus at Limitless Investing is on value-add opportunities, as we believe they provide investors with an optimal mix of immediate cash flow while still providing significant long-term growth potential.
With that said, we believe it’s important for investors to understand each of the different strategies, including the pros and cons of each approach.
Core assets are the safest investment strategy, but they offer lower returns. Of the four strategies, this one most closely resembles bonds. These assets consist of stable properties in major metropolitan areas like high-rise office buildings or downtown apartments in cities such as New York City, Chicago, San Francisco, or L.A.
These are top-notch properties in prime locations with high occupancy rates and tenants with good credit. Since these assets are expensive and large, they are typically owned by well-funded entities such as REITs and institutional investors.
As these assets are already stabilized and achieve market rents, there is limited potential for investors to add value, which restricts their potential profits. However, during an economic downturn, these assets are typically the last to lose tenants.
These investments offer a low-risk profile with limited opportunities for value-added benefits and usually result in single-digit annual returns.
The Core Plus strategy comes next on the risk ladder, and true to its name, it has many of the same qualities as core real estate. Both focus on stable, mature real estate with reliable tenants.
Core Plus, however, focuses on real estate that’s a little bit lower quality (or not as centrally located) as core. They both aim to hold the property for a while and sell in the future, but in the meantime, core plus will make small improvements to the property. Those improvements might include better furnishing and minor updates to old systems, but they rarely (if ever) include major redesign.
Annualized leveraged returns on these assets generally range from 10% - 14%.
Value-Add assets represent the next step up on the risk-reward ladder. While core plus has an element of property improvement, value-add requires more capital investment to make property and operational improvements. This strategy has less of a focus on stabilized income-producing buildings and more of a focus on forced appreciation through increasing the NOI.
The buyer typically purchases such assets with a specific business plan to improve and optimize their performance. By executing this plan effectively, the new owner can turn the asset into a more profitable one, similar to a core-plus property.
These investments require more risk and effort to succeed but can provide high returns of 15% - 20%.
Opportunistic assets represent the highest rung at the top of the risk ladder. These deals usually involve extreme turnaround situations where major problems need to be overcome, such as significant vacancy, structural issues, or financial distress. They are also known as Distressed Assets, and the strategy may involve acquiring foreclosed assets from banks or servicers, or purchasing senior loans at a discount with an eye towards eventual foreclosure.
After the 2008 recession, many opportunistic investments were available as daring investors purchased properties in distress at a steep discount from their previous trades. However, executing these deals can require special expertise to turn them around or patience to wait for the market to recover before applying a value-added strategy once tenant demand returns.
Opportunistic investments carry the highest risk but can provide annualized leveraged returns of over 20% due to the greater expertise and risks involved.
Knowing the difference between these four strategies is essential for properly analyzing a private real estate syndication and knowing where they might fit in your portfolio based on the risk/reward profile.
Specific to value-add and opportunistic deals, investors also need to keep in mind that the expertise of the sponsor and their ability to create and execute a business plan can be critical to the success of a project.
This is why sponsor due diligence is a critical aspect of our due-diligence process prior to any specific opportunities are made available to our Investment Club.
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