Analysis of Real estate investment Strategies

The real estate landscape consists of 3 primary investment types with varying degrees of risk and return.  They are as followed:

  1. Stabilized investments
  2. Value Add investments
  3. Opportunistic transactions

Stabilized properties are commercial assets that have at least the overall market occupancy or are 95% occupied.  They are fully leased up and risk is really only inherent when a tenant lease is coming due and the need to renew or release the space is imminent.  These properties are deemed the safest to investors versus value-add or opportunistic.  They are fully leased at market rates.  Examples include single tenant, triple net retail and 100% leased office buildings.

Value Add real estate investments usually involve cash flowing properties but aren’t fully leased and often need improvements and a repositioning within the market.  These improvements could involve physical enhancements to the building, adding amenities, or just involve superior management.  This will attract tenants to the property and/or increase rents.  Value add investors often utilize higher leverage in the form of bridge or mezzanine financing to take the property from under-utilization to capacity.  The returns can be very attractive but risk is also higher if the operator fails to meet the objectives as sought after in the business plan.

Opportunistic transactions are similar to value add investments but often involve significant rehabilitation or ground up development to realize their potential and fulfill the investment plan.  Often times there is little to no occupancy and the building may be a shell from someone else’s poor use of leverage, think Sam Zell, a.k.a. the “Grave Dancer”.  The plot may also be raw land which needs construction financing to even get a structure into place.  This investment strategy is the highest risk but also yields the highest rewards.  If executed successfully and for the right basis, the returns can be substantial.  If executed poorly or with improper use of leverage, the developer may go bankrupt.

The type of strategy employed by an investor often is a function of their utility function.  Investors seeking higher investments with a higher risk/return profile will often utilize opportunistic or value add investments with a large degree of rehabilitation needed for the project.  Investors with a smaller appetite for risk often seek stabilized properties to offer a “coupon clipping”, bond-like investment.

Learning the Ropes

Up until now, I have been in 2 different games:

  1.  Working as an executive or owner in the restaurant industry.
  2. Working as a trader, researcher, or support staff in the financial industry.

I longed to grow a hedge fund, but I firmly believe that you can no longer be successful in that industry unless you have at least one of the following things in your favor:

  1.  You are well-connected in the industry and someone seeds you with +$100 Million.
  2.  You are willing to give away your first-born child to a capital seeder to take your strategy/strategies to the next level.
  3. You are already rich and can just manage your own money and if you perform well, others will follow.

I know people with returns over 15% and Sharpe ratios > 1.5 who still can’t achieve $100M in AUM (assets under management).  This is bare minimum for institutional capital injections and I would say that it is now more like $150 – $200 M.

So while attending Executive B-School, I met a real estate syndicator and have become more interested in what he does for a living.    I have invested with him and been very pleased with the results.  He has an excellent track record.

A real estate syndicator puts together a group of investors to buy bigger deals that matches the risk/reward profile of the investor with the syndicator.  In private equity terms, the syndicator is termed the General Partner (GP) and the investor is termed the LP (Limited Partner).

But first what constitutes the best deals?  There are 4 general risk/reward categories of real estate investing:

  1.  Core investments are considered to be the least risky because they often target stabilized, fully leased, secure investments in major core markets.  These include properties with long term leases in place to high credit tenants and Class A buildings in highly desirable locations.  These buildings are often well kept and require little to no improvements on behalf of the new owner.
  2. Core Plus: Investors who generally want a safe return, but are looking for a little bit of upside prefer Core Plus.  These properties are match the physical description of Core investments, but usually have some opportunity to increase Net Operating Income (NOI).
  3. Value Add commercial real estate investments typically target properties that have in-place cash flow, but seek to increase that cash flow over time by making improvements to or repositioning the property.  This could include making physical improvements to the asset that will allow it to command higher rents, increasing efforts to lease vacant space at the property to quality tenants, or improving the management of the property and thereby increasing customer satisfaction or lowering operating expenses where possible.
  4. Opportunistic real estate investments follow the value add approach but take it a step further on the risk spectrum.  Opportunistic properties tend to need significant rehabilitation in order to realize their potential.  Often times these assets will be fully vacant at the time of acquisition or the operator will seek to develop raw land from the ground up.  These types of projects offer the highest level of return if the business plan is successful, but also bear the most risk as the properties have little to no in-place cash flow at the time of acquisition and have the most complicated business plans.
          -courtesy of and

I find myself as well as the GP I have invested in squarely in the Value Add category.  I definitely want some risk, but not full on development, unproven demand risk.  More to come…