Real Estate Strategies: Core, Core Plus, Value-Add and Opportunistic Investments

Developing an Investment Strategy

An active fund manager's role is to efficiently allocate clients' capital by robustly managing risk and delivering returns over a market benchmark. Managers utilise their networks, sector expertise and scale to produce desired returns. Typically, a manager would employ a combination of strategies to better manage their clients’ funds with the goal of achieving market outperformance. The strategies are supported by rigorous analysis of trends, micro/macro themes and product pipeline.

What Strategies do Real Estate Investors employ?

Real estate investment strategies are differentiated through risk tolerance and required return profiles. When establishing a fund, firms will develop an investment thesis ahead of allocating any capital. This thesis will dictate the fund's acquisition strategy and employment of leverage. The market often distils investment strategies into four tiers: Core, Core Plus, Value-Add and Opportunistic.

The Four Tiers of Commercial Real Estate Investment

Core

• Risk:Low
• Return: Low (6% - 9% IRR)
• Leverage: 0% - 30% (LTV)

Core investments typically represent a 'defensive' strategy; the Core investment philosophy focuses on slow, consistent returns through steady rental income growth. To achieve this, investors target premium assets occupied by quality, credit-worthy tenants on long term leases.

Core assets are well-located in metropolitan hubs with high demand and significant land supply constraints. Commercial property investors often liken Core strategies to an investment in bonds due to the stability and predictability of return.

A fundamental advantage of Core investments is the ownership of a physical asset, providing exposure to inflation-adjusted returns. The conservative Core strategy seeks to employ minimal leverage and adopt extended holding periods to spread and reduce risk.

As such, Core strategies benefit from often negligible foreclosure risk and broadly consistent performance throughout business cycles, given the high-quality nature of assets acquired under this strategy. Accordingly, the Core investment strategy is well-suited to those targeting passive income generation.

Core Plus

• Risk: Low – Moderate
• Return: Low – Moderate (9% - 15% IRR)
• Leverage: 30% - 50% (LTV)

Core Plus is a strategy varied through the introduction or expansion of leverage and capital growth opportunities. This investment strategy is associated with a low to moderate risk profile and is similar to an 'income' investment with added growth provided through redevelopment opportunities.

The Core Plus strategy targets assets comparable to that of a Core strategy. However, the overall risk and return profile of Core Plus strategies is positioned more aggressively. Under this strategy, investors can achieve increased returns through light property improvements, management efficiencies, or improving the underlying tenant covenant via proactive lease management.

Core and Core Plus strategies typically deliver investment returns founded on consistent rental cash flow with capital appreciation as a bonus. The Jasper Industrial Income Plus Fund is an example of a Core Plus strategy. The Fund targets high-quality industrial assets located in high growth areas, with resilient tenants and long-term leases. The Fund aims to deliver regular, passive income with exposure to capital appreciation over time.

Value-Add

• Risk: Moderate-High
• Return: Moderate – High (15% - 20% IRR)
• Leverage: 40% - 50% (LTV)

"Buy it, fix it, sell it" is the general premise of a Value-Add strategy. Value-Add is a higher risk strategy, with returns mostly dependent on capital value growth via careful, active asset management.

An asset's market value is driven by its risk/return profile. Accordingly, Value-Add investors attempt to achieve capital value appreciation through income maximisation or risk reduction. The asset is transformed into a Core/Core Plus product as rental cash flows are stabilised, and value has been added to the property.

Properties that fit a Value-Add strategy are typically mismanaged, have vacancy issues or deferred maintenance. The vendor might also be suffering from capital constraints. Once identified, an investor will implement a capital-renewal program to maximise value prior to exiting the investment once fully stabilised.

Value-Add investments are subject to execution risk of implementing an asset stabilisation strategy. If the strategy was to fail, an investor might be forced to sell the asset with an overall negative outcome.

Opportunistic

• Risk: High
• Return: High (20% + IRR)
• Leverage: 60% + (LTV)

Opportunistic carries the highest risk of the four real estate investment strategies. The Opportunistic investment strategy focuses on finding, leveraging, and rectifying structural weakness relating to a property to produce outsized investment returns.

The Opportunistic strategy often features purchasing distressed assets via a forced seller or an asset that has been chronically mismanaged. The investment thesis commonly involves acquiring a struggling property that requires significant work to reposition the asset and achieve the site’s highest and best use.

Successfully executing an Opportunistic strategy requires extensive property experience and management acumen. Irrespective of a fund manager's experience, the high-risk level makes this an inappropriate strategy for many investors.

Opportunistic strategies will often consider all property types, including raw land, development opportunities and alternative property assets such as student accommodation, and cool stores.

Diversification is a crucial part of an investors' overall strategy and utilising various investment approaches across the risk/return continuum is a proven way to optimise an investors' return and achieve a well-balanced investment portfolio.

Key Takeaways

Commercial real estate is an excellent investment vehicle for delivering a risk-adjusted return. However, it is vital to assess investment opportunities based on individual risk appetite and desired rate of return.

Depending on the provider's investment strategy, an investor may benefit from allocating capital across all four strategies or focusing solely on a conservative Core or Core Plus portfolio.

Investors must understand the different strategies in order to ascertain the one best suited to their investment objectives. A conservative investor focused on income generation should be investing in higher-quality properties with low leverage or in a debt fund that lends money.

Those with a larger risk appetite and a longer time horizon should consider Value-Add or even Opportunistic strategies. Leverage will amplify both investment risk and return. Investors should be wary of advertised high-yield Core/Core Plus opportunities as they are likely to incorporate higher leverage or take on additional risks unsuitable for a defensive strategy.

By clearly identifying the strategy deployed in each of its offerings, Jasper aims to streamline the investment decision-making process, providing access and transparency within an investment class traditionally only available to a select few.