Understanding the Differences Between: Core, Core Plus, Value-Add, and Opportunistic Investments
What are Core, Core Plus, Value-Add, and Opportunistic Investments?
Core, core plus, value-add, and opportunistic investments: the four types of investment approaches that real estate private equity groups use to find properties that are in line with their goals and overall approach.
In a previous article on real estate private equity groups, we talked about a few different factors that differentiate one group from another, including sector, strategy, geography, capital structure, and deal flow. Today, we’re looking in-depth at one of those in particular: strategy.
At Valiance, for example, we said our investment approach was “value-add” and “opportunistic.”
We’re going to dive into exactly what that means, along with the definitions for “core” and “core plus.”
Why Does This Matter?
First, let’s address why -- why does any of it matter?
Without knowing the four strategies listed above, you won’t have a clear idea of the potential risk and return goals for each firm that you analyze. If one of your clients is looking for the highest returns possible with the capital that they’ve entrusted to you -- or if they’re specifically looking to avoid high-risk investments -- you need to know which option fits their portfolio the best. If you’re interested in investing in real estate, knowing the differences between these four strategies is essential.
Furthermore, experts and firms tend to use this language to make their pitches more concise. There are certain characteristics associated with each strategy, and the term itself just summarizes that information to make it easier for intelligent investors.
Core Real Estate Investments
Core is the safest and most secure of the four investment strategies. It’s also the strategy with the lowest expected return: roughly 6-10%, or lower.
Core investments tend to focus on securing income-producing, Class A real estate in major cities with high credit score tenants on long-term leases, holding it for a few years, and then selling. The goal, of course, is to earn money on the appreciation or market timing of the acquisition and sale, using the income from tenants to break even or cash flow. Equity groups that focus on core investments aren’t looking to fix and flip a property. They’ll keep it more or less the same while collecting income from tenants to guarantee predictable income. Of the four strategies, this one most closely resembles bonds. Firms tend to stress the reliability and safety of this approach.
It’s a good option for older investors who are looking for a guaranteed income in retirement, but younger investors and investors geared toward higher-risk, higher-return investments should look elsewhere. This strategy is geared toward minimizing risk, not maximizing returns.
So, core real estate tends to focus on:
- Class A property
- 6-10% expected returns
- Densely populated areas
- Stable, mature properties that have a history of producing income
- Reliable tenants with high credit scores
- Using as little leverage as possible (25-35% or less)
- The goal? Hold, collect income from leasing, sell in the future
Core Plus Real Estate Investments
What is the difference between core and core plus real estate?
Well, true to its name, core plus 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.
There could also be some other minor differences. Perhaps a core plus investment doesn’t demand tenants who are screened as thoroughly as a core real estate property and the cash flows might be a bit more variable.
- Some Class A but mostly Class B property
- 8-12% expected returns
- Densely populated areas and suburban areas
- Stable, mature properties that produce income
- Reliable tenants (but perhaps not as reliable as core)
- Have a looser relationship with leverage (30-60%+)
- The goal? Hold, collect income from leasing, fix up slightly, sell
Value-Add Real Estate Investments
Value-add is an additional couple rungs up the risk-and-return ladder than core and core plus. While core plus has an element of property improvement, Value-add requires more capital investment to make property improvements. This strategy has less of a focus on income-producing buildings and more of a focus on appreciation by renovation and redesign of Class B & C buildings. (It should be noted, however, that many core and core plus investments also receive most of their return from appreciation upon the sale, just by waiting for the market to grow, but the key difference is over how much time? With Value-Add, the appreciation is typically captured much sooner).
Value-add investments could include distressed and discounted properties in growing markets, introducing the possibility for renewal. Very simply, “value” is “added” to the property by physical improvements, and even operational improvements in the management structure. At Valiance, for example, we manage all properties and do all construction in-house, capturing value at every step of the value chain. Our vertically integrated approach ensures greater control of costs, project schedule, and operational quality and efficiency.
- Class B & C property
- 12-17%+ expected returns (Valiance has a 24.3% annualized return since inception in 2010 -- but returns that high are not always expected or possible for many firms)
- All types of areas
- Buildings might be slightly run-down or in need of repair
- Might be lower occupancy
- Requires a lot of capital to wait out periods of low occupancy and construction
- High upside
- The goal? Find high-potential buildings in burgeoning markets, fix them up, secure tenants, sell.
Opportunistic Real Estate Investments
Opportunistic real estate is also very similar to value-add. Opportunistic property’s relationship to value-add is similar to core plus’ relationship to core: it’s more aggressive with a higher risk and a higher potential return. At Valiance, we also focus on opportunistic properties, hoping to maximize returns on some of our holdings.
The bullet points are nearly identical to the ones included above, except with higher expected returns:
- Class C property
- 15-25%+ expected returns
- All types of areas
- Buildings in need of repair
- Low occupancy or vacant
- Emphasis on redesign, renewal, and revitalization
- High upside
A Note On Different Strategies
It’s important to keep in mind that there’s no governing body that determines if an investment is “core” or “core plus.” Core vs core plus real estate is determined almost entirely by the fund itself, so take every definition with a grain of salt.
Analyze what the group actually does -- not just what they say they do. Always do your due diligence when analyzing an investment. While these definitions may give you an idea of the type of property that a private real estate equity group is interested in, they’re by no means a guarantee.
Is Value-Add Riskier Than the Others?
Yes, but that risk carries with it a much greater potential for gain.
Core and core plus real estate investments are certainly designed to have less risk than firms that focus on value-add and opportunistic investments. By and large, they typically do have less risk, but we’d like to note that chasing stability doesn’t guarantee returns.
For example, JP Morgan released an analysis of companies in the Russell 3000 index, a collection of the 3000 largest publicly-held companies in the United States, and found that “roughly 40% of all stocks have suffered a permanent 70%+ decline from their peak value.” What does that imply? Even for large, “safe” companies in established markets, almost half of them at any given point are likely experiencing decline that they’ll never recover from.
Every investment carries risk, and when you’re investing in a smattering of real estate properties, that risk is usually intrinsically linked to the markets themselves, not just the firm’s approach. That’s why Valiance Capital focuses on growing markets in California and Texas.
Many investors tend to assume that past performance guarantees future results, but the reality that we’re seeing in today’s hyper-growth investment environment can be much different. That’s why we aim to maximize return and deliver the greatest possible benefit to our investors.
Knowing the difference between these four approaches is essential for properly analyzing a private equity real estate group and knowing where they might fit in you or your client’s portfolio.
As a quick recap, here are the characteristics associated with each strategy:
- Class A property
- 6-10% returns
- Lower leverage
- Buy stable, income-producing property, collect income, barely touch property, sell for gain
- Core Plus
- Class A and B property
- 8-12% returns
- Looser relationship with leverage
- Buy lower-quality properties, make small improvements, improve tenancy rate, collect income, sell for gain
- Class B & C property
- 12-17%+ returns
- Requires more capital to wait out low tenancy periods and construction
- Buy distressed and discounted properties, fix and redesign, sell for gain
- Class C Property
- 15-25% returns
- Similar to value-add, except more aggressive and higher-risk
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