Institutional investors share the common goal of generating revenue by building a value-driven portfolio, but different investors accomplish this in different ways. Depending on risk tolerance, fund specifications and expertise, there are several types of real estate investment, as well as real estate investment strategies, that investment managers can employ. While there is no one “best type of real estate to invest in”, each strategy presents unique benefits and risks.
Read on to learn more about the four main commercial real estate investment strategies, as well as the risk and reward factors that differentiate them.
- Types of Real Estate Investment
- Real Estate Investment Strategies
The 5 Different Types of Real Estate Investment
As the market evolves and continues to adopt new technologies, new ways to invest in real estate continue to emerge. These are some of the most popular types of real estate investment through which investors deploy capital:
- Residential: Residential real estate investors own single-family homes and rent them to tenants, or flip them to buyers
- Commercial: Commercial real estate investors acquire, sell, develop, and lend for industrial, office, retail, multifamily, hotels, and other commercial buildings
- Raw land: Raw land investors purchase land to either develop or sell for profit, which typically requires significant capital and awareness of zoning, development and other considerations
- REIT: Real estate investment trusts, or REITs, are publicly traded entities that invest in and own commercial real estate, enabling investors to own shares in buildings
- Crowdfunding: Crowdfunding platforms offer non-institutional investors access to investments typically only available to institutions
While there are many different types of real estate investment to choose from, commercial real estate remains one of the most profitable ways to generate returns. For the purpose of this article, we’ll focus on commercial real estate investment strategies.
Understanding The Four Main Commercial Real Estate Investment Strategies
When it comes to commercial real estate investment strategies, there are four main approaches: core, core plus, value added, and opportunistic. These investment strategies are not fundamentally different from each other–in all cases, investors buy properties with the goal of generating returns. Furthermore, investors typically screen deals through the same data-driven analysis and due diligence processes across these investment strategies.
Crucially, though, the balance between risk and return varies by strategy, which is often influenced by the type of real estate investment fund.
Summary: The standard “buy and hold” investment strategy in which investors purchase high-quality buildings that generate stable revenue
Typical IRR: Below 10%
Core investments enable investors to create value by buying and holding ideally located, high-quality buildings and portfolios. This real estate investment strategy presents relatively low risk, given that these properties retain value well. Because the risk is low, internal rates of return tend to hover below 10%. As class A properties are highly sought after by tenants, there are typically few vacancies that detract from revenue.
Core investors generate returns namely through revenue, rather than capital appreciation. Because core investments are typically class A buildings, they generally won’t require capital injections to generate the target revenue.
2. Core Plus
Summary: A relatively low-risk investment strategy in which investors add value to mostly stable buildings with revenue-driving renovations
Typical IRR: 10-14%
Like the core real estate investment strategy, the core-plus approach revolves around acquiring and holding assets. In this case, though, investors take on slightly more risk. Core-plus buildings typically involve some risk, in the form of the building’s condition, location, age, or another factor that might impact value. Generally, though, core-plus buildings carry relatively stable value.
Core-plus investors add value by either filling significant tenant vacancies or making renovations. For example, a core-plus investor may acquire a high-quality building, then add amenities that drive higher-paying tenants. This real estate investment strategy typically generates an internal rate of return around 10-14%.
Summary: A relatively high-risk investment strategy in which investors acquire buildings in need of capital for a 5-7 year period
Typical IRR: 15-19%
Investors with a higher appetite for both risk and reward might pursue value-added strategies. Value-added investment strategies generally focus on buildings that, for one reason or another, require capital and execution to reach profitability. This investment can take the form of renovations, repositioning the asset to a new asset class or tenant, or simply filling significant tenant vacancies, creating stability.
It often takes at least 5-7 years for the property to appreciate to the target internal rate of return. The appeal of value-added deals, though, is that fully appreciated value-added buildings can sell for well above the initial purchase price. Value-added investments can be a more affordable way for investors to gain a foothold in major markets, without paying exorbitant prices for established, fully occupied properties. For value-added real estate investment strategies, internal rates of return are generally around 15-19%.
Summary: The highest-risk investment strategy, in which investors acquire buildings that need significant investments to achieve profitability
Typical IRR: 20%+
Opportunistic real estate investment strategies cause investors to incur the highest level of risk, but with the highest potential for returns. These investments typically require a significant capital injection to address dire flaws and become profitable. In some cases, investors might buy dilapidated buildings to make thorough renovations. In others, they might purchase low-occupancy or vacant buildings and lease more tenants until it reaches stability.
Developments are sometimes considered opportunistic investments, as these projects require complete funding for construction. Opportunistic real estate investment strategies can deliver returns as high as over 20%, making them particularly attractive to some investors.
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