SPONSORED: Understanding Expected Returns vs. Risks in Commercial Real Estate

When investing in commercial real estate, it’s important to understand each investment type and the average return on investment (ROI) before committing your capital. Whether you’re buying retail, office, industrial or multifamily, determine which asset class best represents you to determine your risk tolerance and find the right investment that meets your goals. We have found that savvy investors typically spend a great deal of time planning with a trusted real estate advisor to educate themselves on current market conditions and expected risks/returns before making their first investment.

When measuring investments and their offered rate of return, we look at the following characteristics: location, CAP rate (CAP rate = net income ÷ purchase price), income growth over a holding period, strength of tenant(s), length of tenancy, and management intensity. Understanding these different attributes helps investors determine the level of risk each investment offers and gives them the ability to see which properties are overvalued, undervalued or in line with market prices.

Below are examples of five asset classes commonly used by investors and real estate professionals to classify commercial real estate investments:

Risk Free (Non-Real Estate)

Risk-free investments are non-real estate investments such as bonds, CDs (certified deposits), money market accounts, savings accounts, government bonds, and debentures. These are considered risk-free investments due to their fixed returns and high liquidity. Due to their safe nature, these investments are the lowest on the return spectrum compared to all other commercial investments. Understanding risk-free commercial real estate investing is important as it provides a foundation for all of the other asset classes below and can shape the market.

core

Core investments are probably the most sought-after properties in the commercial real estate sector and can be single-tenant or multi-tenant. These investments can be single or multi-tenant properties and often include long-term leases backed by strong corporate tenants such as Starbucks, In-N-Out and Walgreens, to name a few. For single tenants, the average remaining term of the lease is around 10 years, for multiple tenants a mix of 5-10 years. There is little to no management for these properties and most investors’ strategy when purchasing is a long-term hold plan. From a risk perspective, these investments offer both the lowest risk and the lowest return.

CorePlus

Core Plus investments can be either single or multi-tenant and offer investors an increase in return and risk compared to core investments. These properties can include as little as one renter to more than twenty. With a larger number of tenants and higher yields, owners may be faced with shorter leases that offer a higher chance of vacancy and constant lease negotiations/renewals during a period of ownership. These properties tend to consist of smaller tenants rather than national tenants. The increased day-to-day commitment of the owner and the higher risk of vacancy are why the returns on these investments are higher than core assets.

added value

Value-add investments are some of the riskiest real estate on the market. These investments are the traits that low-risk investors tend to avoid, and usually involve some sort of problem that needs solving. Whether it’s high vacancy, deferred maintenance, short leases, or larger vacancies that aren’t in demand (think vacant K-Marts and drugstores), these investments are attractive to investors as they represent an opportunity to add value and see increased returns. Value-add buyers are considered full-time investors and are very active in the day-to-day operations of these properties.

Opportunistic

Opportunistic investments, often made by the most experienced investors, carry the highest risk and can deliver very high returns for owners if executed successfully. Examples of opportunistic real estate are vacant buildings or shopping centers, brownfield sites to be developed and demolitions with replacements at the highest and best use. Investors will look at these investments with a long-term plan unless they flip or do something high-risk, short-term early on. A lot can go wrong and the risk is very high due to a multitude of assumptions and unknowns. Owners may face the risk of losing their initial investment entirely.

What is your risk profile?

Understanding your risk profile and the asset class you fit into is the first step in making the right purchase for your current needs and goals. If you’re looking for a long-term investment that generates steady cash flow, then a Core or Core Plus asset could be for you. If you think high risk is worth taking, then value-added and opportunistic real estate may be a better fit.

Consult an investment professional

At Visintainer Group, we carefully analyze each client’s situation, risk tolerance and goals to develop a customized strategy tailored to their needs. Whether purchasing your first commercial investment or expanding your portfolio, our proven track record and market knowledge ensures clients invest in the property that suits them besthergoals, not ours.

John Kourafas, CCIM, is a commercial investment advisor at Visintainer Group in Fresno, CA. The Visintainer Group was founded in 2018 and is based on investment properties. It is a customer-centric commercial real estate company. The group has completed over $550 million in transactions across the United States. John specializes in acquiring and disposing of commercial real estate for owners in the Central Valley, Sacramento and Central Coast markets. He can be reached at 559.890.0419 orjohn@visintainergroup.com.

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