Add Wealth Through Value-Add Real Estate Investments
When it comes to real estate investing, what’s the appropriate amount of risk and return?
One of my favorite Ben Stiller movie roles is his paranoid, risk-averse actuary in 2004’s Along Came Polly. We know he’s always on the lookout for the next falling piano, but he has his neuroses down to a decimal point:
“I know that I have a .013% chance of being hit by a car on my way home. Or a one in 46,000 chance of falling through a subway grate. So, I try to manage that risk by avoiding danger and having a plan and knowing what my next move is.”
Whether it’s subway grates or investment properties, we all have our risk parameters. But just as important as the risk evaluation is the ability to see opportunity and potential for relatively greater returns.
Value-add properties may be your preference for wealth creation when investing in commercial real estate.
3 categories of real estate investments
The best way to break down real estate investments is to look at three main categories:
- Core and Core Plus – These are more stable and secure properties, usually Class A quality. They typically have lower vacancies and strong credit tenants. These properties generally command higher purchase prices because they’re a fairly secure bet and provide a predictable but relatively lower cash flow.
- Opportunistic – These properties sit on the other end of the risk spectrum and typically include highly stressed properties or empty land parcels. It’s up to the investors to create a plan for increasing the property’s equity dramatically, usually through development, lease up or parcel sales, or a combination thereof. When successful, these investments provide relatively higher returns.
- Value-Add – These properties sit somewhere in middle: some risk but also the chance for healthy profits. They typically all need something that a strong operator can provide, such as repositioning, capital improvements, better management and leasing, higher rents, etc.
- Inspections – Keep track of all required inspections (such as fire sprinklers) so you don’t incur any citations. Be sure to look at both state and local codes and mark them on the calendar.
We and our investors are often attracted to the value-add properties because we can see the potential “trapped value” – whether that be physical, operational or economic – and can visualize a path to freeing that value and maximizing profit.
Maximizing value from value-add
Once the value-add property has been improved (which increases the operating income), it can usually be sold at a higher value. That appreciation typically means a higher return than a core property investment. And while the gamble is greater, many investors we work with enjoy that balance of risk and return, and they appreciate the cash flow after the property is acquired with the increased potential down the road.
Brad Capas espouses some of the benefits of value-add in an article for CIRE Magazine:
“Value-add investment blends art and science. Success requires creativity to uncover an asset’s hidden potential and strategic discipline to execute an enhancement program that maximizes results … As long as properties age and market conditions change, opportunities to harvest new revenue and drive value will continue.”
Of course, choosing the right value-add property is trickier than it looks. It takes a skilled operator who has the vision and the capabilities to execute the right strategy. Besides understanding the physical property, the operator needs to look at how it’s competitively positioned in the market, its current cash flow, and its leasing prospects on the horizon.
Copaken Brooks is an ideal partner for many investors wanting to create wealth through real estate investing. Over the past 95 years, we have developed and invested in various real estate properties totaling millions of square feet built throughout Kansas City and the Midwest.
We work with a wide range of investors, each with their own tolerance for risk, so we’ll help you evaluate many types of properties to find those that match your preferences regarding timeline, risk and return.
You may still have a minute chance of getting hit by a car on your way home tonight, but at least you’ll know your real estate investments are in safer hands.