Commercial real estate is an excellent addition to any strong, diversified investment portfolio. As a relatively stable asset with high return potential, it provides plenty of options to fit a variety of investment goals.
However, entering the world of commercial real estate investment can be confusing. With so many property types, investment styles, and market factors to consider, even experienced investors can struggle to find the best options. Read on for five major strategies (and a few bonus tips) to start your CRE investment journey off strong.
Top Five Investment Strategies
When deciding how and where to invest in commercial real estate, the first step is to understand your risk tolerance. Your risk tolerance describes the stability (or not) you’re looking for in an investment. Higher-risk properties often have higher potential rewards.
Consider your goals for returns when deciding how to balance potential profit with stability. Take a look at each type of investment strategy below to learn how they differ in risk and return.
1. Core Investments
Core investments are stable and high-quality. They are usually located in very desirable locations, require minimal improvements, and are nearly (or completely) filled with tenants in long-term leases. Due to their quality, core investments are dependable sources of income, though they are less likely to provide very high returns. Their stability is what makes them “core” investments, often forming the basis of an investment portfolio.
2. Core Plus Investments
Relatively desirable properties with room for some improvements or slightly more volatility. Core plus investments may need minor maintenance, repairs, or updates, but be in a good location with tenants. These properties may also be well-maintained but have shorter lease terms. Either way, core plus properties are a good mix of relative stability and the opportunity for higher returns.
3. Value-Add Investments
Value-add investments have high potential, but require larger spending up front to reach it, creating higher risk. You may have to perform major renovations or repairs or deal with high vacancy rates in order for these properties to thrive. While they offer the potential of high returns, value-add investments may be strongly affected by market changes.
4. Opportunistic Investments
Opportunistic investments are the highest-risk category of commercial real estate properties. These properties, usually either developments or properties in distressed areas, require intensive work and spending up front. They are also very dependent on market changes. Market growth is one way that opportunistic investments can result in high returns, but a downturn can be very costly.
5. Indirect Investment Options
Rather than directly buying properties yourself, you can also take advantage of indirect options. Popular options include real estate investment trusts (REITs), private equity funds, and syndications. Each of these allow you to invest from a distance and share management responsibilities. Here are the main differences:
- REITs: companies that own or run commercial properties. REITs usually allow for diverse investment, steady income, and liquidity.
- Private equity funds: when a group of investors come together to fund a project. These are usually less liquid and tend to focus on large-scale value-add or opportunistic investments. They are higher risk, higher reward.
- Syndications: pool funds from investors similar to a private equity fund. Shared investment may reduce risk and day-to-day management needs.
Other Considerations When Building an Investment Strategy
Aside from investment type, other factors may influence if a property is a good fit for you. Aspects like property type, location, and financial or market metrics add an extra layer of complexity when determining the risks and potential returns of an investment.
Property Types
Conduct thorough research on different commercial property types and their fit for your goals. Examples of commercial properties include:
- Strip malls and retail locations
- Healthcare buildings
- Offices
- Warehouses
- Industrial buildings
Learn the different requirements of property types you’re considering. Healthcare buildings, for example, must accommodate medical equipment. These unique requirements can be an opportunity for added value, but can also represent extra costs.
Many experienced commercial real estate investors work to include a variety of property types in their portfolio. Diversifying in this way can help protect you if one type begins to struggle.
Location
It’s important not just to be familiar with overall trends, but also with local needs and unique environmental factors. For example, a coastal town prone to flooding increases the overall investment risk. Additionally, not every property type is a good fit for every location. A strip mall, for example, is a much stronger investment when it’s easily accessible and close to residential areas, rather than in a remote spot.
Financial Metrics
Be sure to carefully evaluate the property’s performance. Check key metrics like capitalization (cap) rate, cash-on-cash return, and net operating income (NOI). These metrics will help you determine if the property is a core, core plus, or a riskier investment.
Similarly, do your due diligence by analyzing not just the property, but surrounding market trends. How has this type of property been performing? Are there any indicators that it might significantly rise or fall in demand? These questions help you ensure that your investments meet your long-term goals.
Keep Track of Your Growing Portfolio with STRATAFOLIO
Whether you’re an experienced commercial real estate owner or just getting started, investing is a complex process. Between managing your current properties and evaluating potential purchases, you constantly handle huge amounts of information. You juggle lease terms, financial metrics, market trends, and more.
STRATAFOLIO is designed to help you track and organize all this data, keeping it in one easy-to-navigate location. When you don’t have to go digging for the details you need, you can make faster, stronger investment choices for your portfolio. To learn more about the tools STRATAFOLIO offers for commercial real estate investors, schedule a free 1:1 demo today.