There are five general risk categories that most commercial real estate investments fall into. While different property types have different inherent risk profiles – for example, multifamily investments are generally considered safer that retail investments – all property types can be classified under these risk categories. Remember, the greater the risk, the greater the reward.
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Core
Core investments are considered the safest and thus tend to be the most expensive. These are stabilized assets in the best locations of major markets. They have been recently developed or redeveloped and require minimal capital expenditure. Because they are stabilized and relatively new or updated, there is not much value to be added or upside to realize. Returns are typically upper single digits.
Core-Plus
These assets share many characteristics with core assets but have at least one characteristic which adds risk and creates an opportunity for higher returns. Examples of these characteristics include, older vintage, slightly inferior locations, secondary or tertiary markets, mismanagement at the asset or property level, and minor deferred maintenance. While these opportunities are slightly riskier than core opportunities, they are still considered safe investments, though they typically require higher capital expenditures. Think of “core-plus” as “core” plus a little bit of something to juice returns. Core-plus returns are typically low to mid double digits.
Value-Add
Value-add opportunities generally have at least one problem that needs to be solved and will often require a management overhaul and/or considerable capital expenditures. Examples of problems include high vacancy, outdate units and amenities, high degrees of deferred maintenance, an uncreditworthy rent roll, and even zoning issues. These opportunities can be found in primary, secondary, or tertiary markets. These deals involve a fair amount of risk and will require an aggressive asset plan to pull off the rate of return investors require. Returns are typically in the mid to high teens.
Opportunistic
These opportunities are the riskiest, and the properties typically suffer from major problems like severe vacancy, outright neglect, structural defects, or financial distress. They often involve substantial redevelopment plans and complex financing. It takes very well capitalized and competent asset managers to pull these projects off successfully. Costs can get out of hand quickly, and these projects often require a lot of upfront equity that will be at risk of total loss early on in the processes. Returns are typically greater than 20%.
Development
Development is the new construction of commercial real estate either from raw land or a demolished site. The risk profile is nearly identical to the Opportunistic profile and will require similar project management. Returns are typically greater than 20%.
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