Commercial Real Estate
Learn more about commercial real estate and its metrics.
Learn more about commercial real estate and its metrics.
Within private equity real estate, properties are typically grouped into four primary categories based on investment strategy and perceived risk. Those four categories are core, core-plus, value-added and opportunistic. The key differentiator between these categories is the risk and return profile. Moving between those categories is a bit like stepping up the ladder in terms of taking on more risk, and in theory, the potential of being compensated for that risk with a higher return.
Note, however, that investing in commercial real estate entails substantive risk, including risk of total loss of capital, therefore all four categories do carry risk, and that all investors should consider risks specific to that given property prior to investing.
In this article, we’ll explain these four investment strategy categories and some key takeaways.
Core commercial real estate (CRE) investments are generally considered to carry less risk in relation to other commercial real estate investment categories.
These properties are typically fully leased to high credit tenants (tenants with extremely good credit, typically major corporations), and generally require little to no major renovations. These properties are often located in highly desirable locations in major markets. With the potential stability, core holdings are generally not seen to carry as much risk as the other CRE investment categories, however, in turn, they tend to target lower annualized potential return to investors.
The term "core-plus" was originally defined as "core" plus leverage.
Core-plus properties usually require some improvements in order to increase net operating income (NOI), typically either by decreasing operating costs, raising rents, and/or renting to a higher caliber of tenant.
Core-plus commercial real estate (CRE) investments are often typically referred to as “growth and income” investments. Compared to other commercial real estate categories, the cash flow is generally less predictable, but typically they target a higher rate of return than core commercial real estate investments.
Properties are generally considered “value-add” when they have some level of management and/or operational problems, require some physical improvements, and/or suffer from capital constraints.
By making physical improvements– for example, remodeling the apartments in a multifamily property, installing more energy-efficient heating systems in a medical office, adding cold storage to an industrial space, improving the quality of tenants, and/or lowering operating expenses, the owner can hope to increase the property’s net operating income (NOI). This in turn mayincrease the “cap rate” of the property, which is the rate of return based on the income that the property is expected to generate. This could potentially increase the overall value of the building when it sells.
Usually given the amount of work needed to enable the property owner to command higher rents, value-add properties tend to target higher potential returns to potentially compensate investors for the increased amount of risk.
Opportunistic real estate investments are often considered one of the higher risk investment opportunities, usuallyrequiring major development work. Opportunistic properties tend to need significant rehabilitation or are being built from the ground up.
Due to the increased level of risk, they often target higher potential returns to investors than other types of CRE projects, but they generally have little to no in-place cash flow at the time of acquisition and typically have a more complicatedbusiness plan.
Wait, weren’t there four categories? Yes. But let’s cover a subset of opportunistic commercial real estate investments: development. Development usually has many moving pieces that cause these projects to be high on the risk profile. These risk factors mayinclude pre-development risk (surveys, permitting, entitlement), vertical construction risk, arranging permanent financing, leasing, hiring property management, and more.
Development deals also generally don't provide cash flow during the construction phase, but when the property is fully constructed and stabilized they maygenerate income. Due to the increased risk, development projects often target higher potential returns than other CRE projects.
It is important for investors to understand the risk and return relationship when discussing the four different types of real estate investment strategies. The level of the return generallycommensurates with the amount of risk. Investors also need to keep in mind that the expertise of the sponsor and their ability to create and execute a business plan can be critical to the overall success of a project.
A balanced commercial real estate portfolio may include some or all of these different investment categories depending on the risk tolerance and the investment objective(s) of the individual investor. The Vairt Marketplace offers projects across the risk spectrum in each of these categories. All investors should consider their individual factors in consultation with a professional advisor when deciding if an investment is appropriate. Investorsshould carefully review each offering in detail before making an investment on the Marketplace.
The term real estate covers a lot of ground (no pun intended). Commercial real estate (CRE) is a subset of real estate and can include anything from apartment buildings to hotels to warehouses. Understanding a potential investment’s property type and the economic factors that typically affect itmay help you better evaluate if the deal fits into your portfolio. We also encourage you to review investment opportunities with your legal, financial, and tax advisors.
In general, commercial real estate is divided up into four categories: office, industrial, retail, and multifamily. Each property type can be further divided into multiple sub-categories. There are also a number of more “niche” property types that don’t fit neatly within the four, including hotels, self-storage, and senior housing.
In this article, we’ll go over the main four property types as well as some popular niches.
First, let’s look at office. Office buildings come in all shapes and sizes, for example a 100-story glass and steel tower in Manhattan to a one-story bricker in Des Moines. Employment growth is generally a demand driver for office, especially in those industries that are heavy office users like finance, insurance, or tech.
Office properties are generally distinguished by height, location, and use.
Offices are typically organized into three height classes:
Certain types of tenants may prefer one height class over another. Big law firms might prioritize views to impress clients while creative tech users might prefer lower-rise buildings for the easy access to bring a dog to work.
Location for office generally consists of two types: central business district (CBD) and suburban. Think the Loop in downtown Chicago versus Arlington Heights, IL.
Finally, office buildings vary by use. The most common is general office use, with tenants who might be in white-collar professional services and/or tech. However, specialized office use, such as a medical office, might have or need significant tenant improvements and custom floor plans.
Next, let’s cover the industrial property type. Industrial real estate is intended to provide practical and efficient space to businesses that generally prioritize function over form.
Demand for industrial assets is often dependent on the overall strength of the economy and growth—the more people shopping, shipping, and storing, generally the more industrial space is needed. Warehouse space in particular may be affected by export and import activity.
Industrial generally breaks down into three categories:
The third category is retail. Retail property types range from single-tenant buildings, like a stand-alone pharmacy, to full shopping centers with dozens of tenants. Demand for retail space is driven by consumer spending habits and trends.
Retail centers that have more than a single tenant are generally grouped by size and tenant type.
Finally, let’s look at the last of the big four categories: multifamily (think apartment buildings).
Population growth has a big effect on demand for multifamily. When the number of renters in an area increases, the range in apartment property offerings expands to fit their varied needs and tastes. Size, density, location, and amenities break up the multifamily property type.
Multifamily also covers a number of niche property types for specialty markets, such as student housing and Build-to-rent (BTR).
Now that we’ve covered the big four property types, let’s take a look at some of the prominent niche property types.
First, let’s look at hospitality. The main type of property within the hospitality moniker is hotels. Hotels are defined primarily by the services and amenities that they offer, but also by the “flag” or operating brand of the property. This includes brands like Holiday Inn, Hilton, and Marriott, among others.
Unsurprisingly, travel and tourism activity in a specific market largely drive the demand for hospitality assets in that location.
The three main types of hotels include:
The next niche property type is senior housing. The aging Baby Boomer population is attracting more investment capital into this sector in terms of acquisitions, development, and property renovations. Senior housing properties aim to provide both housing and services to seniors, and are generally split up into four categories based on the level of care provided.
The last niche property type we’ll cover is self-storage. Self-storage is a segment of the real estate market that has continued to evolve in the past decade. The traditional rural and suburban properties with gravel driveways and roll-up metal doors are being replaced with modern facilities and sophisticated operators.
Demand drivers for self-storage assets include population growth and density, average household size, and average household income.
Internal Rate of Return (IRR) is a measure of performance commonly used in connection with investments in real estate. It shows a return earned by an investor over a defined period of time, calculated on the basis of cash flows. IRR differs from other metrics in that it accounts for the concept of the “time value of money," meaning it is calculated as the discount rate that makes the present value of all cash flows from an investment equal to zero. IRR can help an investor compare different investments based on their yield, while holding other variables constant.
One of the issues with relying solely on IRR is that it can be misleading if used alone due to the assumption used to calculate it. Although a higher IRR might look good at face value, investors need to understand the factors and assumptions used to derive IRR.
A key term to a real estate private equity deal is the sponsor promote. This term is an industry term for the sponsor’s disproportionate share of profits in a real estate deal above a predetermined return threshold. In this article, we will define the sponsor promote, explore how promotes work, and finally, what sponsor promote means to investors under a direct-to-investor model.
A valuable tool available to investors for evaluating and comprehending risk in real estate investments is the capital stack. For the purposes of commercial real estate, the capital stack can be viewed as the different layers of financing sources that go into funding the purchase and improvement of a real estate project. Ideally, a real estate investment would satisfy its business plan or pro forma target, but, there is risk that this would not be the case. The capital stack helps provide investors with valuable information about where they are in the order of cash flows, and what that order means from a risk of repayment standpoint.
The capitalization, or cap rate, is a term that is used frequently when discussing real estate investments. The cap rate is a ratio including two variables – the net operating income and the current value or sale price of a property. This ratio can help to determine the potential return on an investment. Put another way, the cap rate is the rate at which the net operating income recapitalizes the asset value on an annual basis. The cap rate is a useful tool that is often used to assess real estate investment opportunities and draw conclusions across asset classes.
A common metric for measuring commercial real estate investment performance is the cash-on-cash return, which is sometimes also referred to as the cash yield. The cash-on-cash return rate can provide useful insight into the business plan for a property and the likelihood of receiving regular cash distributions over the course of an investment.
Commercial real estate applies a “class” system as a simple way to convey the characteristics of a potential real estate investment. Real estate investments are classified as class A, B, or C, based on a combination of characteristics - including physical, geographical and demographical. The class can be an important indicator for an investor to gauge a property’s competitive position in a marketplace and where it fits in relation to market value and rents. In this article we walk you through the different property classes and highlight some of the investment opportunities specific to each.
Equity multiples and internal rate of return (IRR) can be two important metrics to measure investment returns. Each is an important analysis tool on its own. But combined, they can provide more insight on the potential benefits of a real estate investment.
A common resource within real estate pro forma, Sources & Uses are shown in a table intended to serve as a roadmap surrounding where the project’s funding comes from (the “Sources of Funds”) and how that funding is to be spent (the “Uses of Funds”). In this article, we discuss the constituent parts of the table and how they differ from other investment tools.
Investors are discovering that investments in real estate can help diversify their overall portfolio of investments. As we drill down into this burgeoning asset class, it is important for investors to understand the important differences that exist between direct and indirect real estate investments, as these differences can have significant impacts on risk, return and diversification.
For those who are not familiar, UBTI is an acronym standing for unrelated business taxable income.
The offerings found on our Marketplace employ debt financing, which means there could be UBTI exposure for investors.
Broadly speaking, ordinary income trade or business activity will be subject to UBTI so if a developer treats income as ordinary income trade or business activity on their tax return, they can ultimately pass through the UBTI exposure to the investors in the particular offering, meaning the taxable income will flow down to the individual investors.
Vairt and its affiliates do not provide tax advice. We encourage investors and prospective investors to consult with a tax professional prior to investing for more information.
Multifamily real estate is a widely held and strategic commercial real estate asset class. While previously considered a residential asset, multifamily is now firmly cemented as one of the four primary commercial real estate asset classes (the other three primary asset classes being office, industrial and retail). In this article, we provide an overview of the multifamily asset class, discuss demand drivers, highlight changes in use and conclude with a synthesis of these factors to better equip investors with the knowledge to make informed investment decisions.
Diversification is seen as a core principle of portfolio management that helps to minimize overall risk and potentially provide investors with a higher overall blended return. Modern Portfolio Theory advocates a 10% - 20% allocation into hard assets, such as real estate, as a way to potentially increase returns while also helping to reduce overall risk. However, the principle of diversification doesn’t stop at the point of a real estate allocation; it can also apply within the real estate allocation itself. Diversification within a real estate portfolio can be achieved, but it requires an understanding of the different levers you can utilize to help diversify. In this article, we explore those levers and highlight the various ways to utilize them to help assemble a well-diversified real estate portfolio.
A risk-adjusted return is a measure that puts returns into context based on the amount of risk involved in an investment. In this article, we walk you through a detailed process for estimating relative risk-adjusted returns across various commercial real estate investment opportunities. After reading this article you should have a better understanding of how risk and returns are related and how they can vary in competing investments.
Some investors like to tour the physical asset or property as part of their own due diligence process when considering a potential CRE investment opportunity. If this is something that interests you, and you either live in the vicinity of the subject property or plan to visit, feel free to reach out to the sponsor of the offering to request a site tour. You can do this using the “Questions?” feature located in the right-hand sidebar of that particular offerings’ detail page.
Below are a few general considerations to keep in mind if touring a CRE asset or property:
Certain statements contained in this document constitute forward-looking statements. Such forward-looking statements, including our intended actions and performance objectives, projections, targets, estimates, or forecasts involve known and unknown risks, uncertainties and other important factors, including our ability to successfully develop and operate the Vairt Marketplace, our business model and the services we intend to offer. These factors are based on expectations and assumptions that may change and are subject to regulatory uncertainty, changes in our legal environment and the blockchain and real estate industries generally, which could cause our actual results, performance or achievements to differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements. All amounts, numbers, ranges, and values presented in this document are subject to material change and should be taken as preliminary and indicative only. Any such amounts, numbers, ranges, and values are based upon preliminary estimates, remain subject to ongoing analysis and may change materially. All forward-looking statements in this document speak only as of the date hereof. We expressly disclaim any obligation to update any forward-looking statement to reflect any change in our expectation or any change in events, conditions, assumptions or circumstances.