We discussed limited partnership investment in commercial real estate (CRE) projects in an earlier video series – you can view those here or sign up for more on Montana investment here.
If you are interested in becoming a limited partner, you’ll want to be familiar with common lingo used in commercial real estate investments. That starts with the four general investment strategies with different risk/return project profiles:
CORE – The Core investment strategy is considered a low-risk approach to CRE investing. Core investment properties are generally newer buildings in desirable locations with high tenant occupancy. The investment strategy uses less leverage to acquire a property and has an extended hold period (7-10 years) for the property. As a result, the benefit to the investor is stable and predictable cash flows from high-quality long-term tenants. As a low-risk CRE investment, a core strategy has lower yet stable returns between 5-8%. Core investments are suitable for investors who favor capital preservation and consistent cash flows more than asset price appreciation.
Risk Profile: Low
Best for: Investors who favor stable cash flow
CORE PLUS – Core Plus investments, like the core investment strategy, have high credit tenants. However, the properties have less desirable locations or features than their core counterparts and may initially have lower occupancy. The core plus building is good but not excellent because it probably needs capital improvement to address a deferred maintenance issue, for example, a roof repair. The opportunity lies in making modest improvements to management or maintenance. A little more debt is acceptable here, generally up to 60%. Core plus assets have slightly higher annual returns than core investment assets, typically between 8-12%.
Best for: Investors favoring cash flow and a little appreciation
VALUE-ADD – Value-Add is where commercial real estate investment strategy starts to get spicy. Value-Add is a real estate investment strategy categorized by medium-risk and medium returns. These investments are underperforming assets with upside potential after adding value through asset refurbishment, re-leasing, and repositioning. Sponsors may use up to 70% leverage to acquire a value-add project and perform necessary upgrades. The goal is to boost net operating income, which in turn, increases the property value. The result is higher cash flow from tenants and capital appreciation at the sale of the improved property. Value-Add internal rate of return is generally between 13-18%. The asset hold period is between 3 to 7 years.
Best for: More aggressive investors with higher risk tolerance
OPPORTUNISTIC – Opportunistic projects allow for great returns – with high risk. The Opportunistic Strategy involves high investment uncertainty and potential cash flow volatility. It is vital to have a sponsor (General Partner) with subject matter expertise. This category offers the opportunity to get the most out of your investment if you have a skilled development team on board to navigate thornier, less straightforward projects. Projects can be new ground-up developments like spec-builds or comprehensive renovation/redevelopment to reposition an asset to a different asset class. The opportunistic strategy employs a significant amount of leverage, above 70%. Return of investor capital may take longer due to construction and property stabilization. With higher risk comes higher rewards, and successful projects can reap 20% or greater returns.
Best for: Aggressive investors with an appetite for risk while seeking substantial returns
CRE investments make for great diversification in an investor’s overall portfolio. Investors need to understand the risk-reward tradeoffs when pursuing a commercial real estate investment. Click below to learn more about limited partnership and CRE investment opportunities in Montana.