Core, Opportunistic or Value Added?

Were you aware that there are three main investment strategy types?

One of the coolest things about investing in real estate is that there is a smorgasbord of investment types you can get into. Whether you're a fix and flipper, note investor, mixed-use, land, commercial, storage facility, or retail investor there really is something for everyone in this industry. But did you know that there are 3 main investment strategy types? Today we are going to be talking about the Core strategy, the Opportunistic strategy, and the Value Added Strategy. Let's dive right in.

Core Strategy

Generally, this is the safest of the 4 strategies. The Core Investment has a goal of maintaining the lowest risk while creating the most predictable cash flow. These investments historically stay in the 7% to 11% of rate of return. Core investments are perfect for the long-term investor. Leverage levels are low to no leverage staying under 25%. So what do these investments actually look like? Well, they are your brand new construction apartment buildings, commercial properties, and some self-storage facilities. Ideally, these investments require no asset enhancements such as rehab or repair. They are genuinely turnkey properties. Tenants are low risks such as high-income tenants or those who backed up with a rent guarantee from a parent company (like a franchise) ensuring that they can withstand cycle downturns.

Such as: purchasing a fully leased, completely renovated, multi-family unit in Los Angeles

1. The tenant mix encompasses both high-income tenant and families seeking stability in their living conditions
2. Low Turnover
3. Rent is at or above the market rent

Another example would include: Purchasing a fully leased Walmart anchored regional shopping center in Down Town Los Angeles

1. You have a diverse mix of creditworthy tenants in a high traffic area
2. Fully leased - prime location
3. Long Leases - Most of these leases range anywhere from 5-30 years.

You will often see Core and Core + strategies discussed together. This strategy is virtually the same as the Core strategy with just a little more risk and a little more reward. Historical rates of return for Core + are between 8% -12%.
Opportunistic Strategy

The Opportunistic strategy is the most aggressive strategy in real estate and surprisingly it's the one we see most often in real estate. The goal of this strategy is to obtain the maximum return potential possible through capital appreciation. Generally, the leverage risk is between 50-80% and the risk is high. This is where we see a lot of investors utilizing other people's money which causes the high risk. Opportunities include targeting highly distressed properties that require major rehab or the development of raw land into residential and commercial properties. Majority of the return of an opportunistic strategy comes from the appreciation of the property rather than the income. There are often times when there will be significant periods of time during construction where no income can be generated at all. While this may seem like a lot of work, the reward is usually more than worth it. Historically the rates of return exceed 12% with a target of 20% IRR. (We'll be going over measures of return in our next newsletter). Fix and Flippers fall into this strategy as they purchased distressed or outdated properties requiring repair and rehabilitation to bring up the value. Let's take a look at some examples.

Example # 1
We purchase a finished lot in a built-out community that has well known, highly favorable, sales comparables.
We build a new home and sell for a profit.
The Risks identified are significant permitting requirements and construction costs and time variables
We buy the land for $120,000
Comps show $1.8 million to 2.2 million
We spend $750k for a custom home and list and sell it for $2.3 million within a 12-month timeframe.
Cash out = 870,000 Cash In - $1,430,000
We are looking at approximately a 300% IRR and a 2.5x Cash Multiple!

Example # 2
We purchase a large retail building from a distressed retailer. We subdivide into multiple smaller units and lease these spaces out to smaller retailers at higher than market rent. This building requires minimum rehab. Before we even close, we are able to lease out 40% of this office space (Unlevered!). Our initial yield is 15% and once fully leased we will be at 30%. Our final return is 66% IRR if we exit at 3 years.

The big thing to remember about opportunistic investments is that it is all about timing. If you are Phase 3 (Hypersupply) you'll want to pay extra attention to the health of your market. These investments will be safe in the beginning but become riskier as time progresses.

Value Added Strategy

The value-added strategy is a great strategy to have for any portfolio. The main goal of this strategy is to create an upside opportunity with some initial cash flow. Think of improving on something that already exists. This strategy involves purchasing some with light to moderate rehab such as something that needs cosmetic work or that has previously had poor management, sprucing it up and selling it for a higher price. This strategy requires moderate to high leverage (40 to 70%). Prime targets for this type of investment is something requiring cosmetic rehab, an area that can sustain a higher rental rate, the occupancy rate is high, you have greater operating efficiency or room for expansion. Historical Rates of return are 10 to 15% with a targeting IRR of 12-20%

Example # 1:
We purchase a poorly maintained apartment building with low market rent rates. The building is only 50% leased. We're starting out with some income but not yet realizing the full potential. The rehab work consists of paint and some new carpets. A few of the leases will be expiring shortly which will allow for rental growth. We are able to rent these units out for $850 instead of $650 once the rehab work is completed. Within a few weeks, we are able to lease this property out at full occupancy and have increased the value of the property for resale. We can hold on to the property for cash flow for a few years and then sell it or we can turn around and sell it turn key to another investor.

So there you have it. The 3 main investment strategies. No one strategy is better for everyone. Your portfolio should be diversified and include a little bit of each depending on the amount of risk you are willing to take. However, knowing which strategy you are in will help you determine the exit strategy and what type of return you should expect in your strategy. Stay tuned to my next newsletter as we embark on this journey for Financial literacy together. We will be discussing measures of return and dive deeper into the meaning of ROI, IRR and Cash Multipliers.