What Are Value Add Properties In Commercial Real Estate?

Sep 14, 2016

Every type of commercial property has its benefits and risks. Deciding which type of income property begins with not how much profit you’d like to make, but rather with how willing you are to take risks.

This can vary greatly from investor to investor, and indeed, may vary depending on the makeup of your investment portfolio at any time. Younger investors tend to be more willing to take risks, while older investors, looking towards retirement, prefer to have several solid income properties that offer a steady return with minimal management responsibilities.

Commercial Property Characteristics

Once you decide the level of risk you’re willing to accept, you might want to look at the various characteristics of both the commercial property and the deal in order to find the best property for you.

Some of these characteristics include:

  • how the property is managed,
  • local market conditions,
  • national industry conditions,
  • the liquidity of the property,
  • the expected return

Another way of determining what type of commercial property suits you best as an investor is to consider the following two important factors: market type and investment type.

Types Of Markets

There are 2 types of markets to consider in commercial real estate.

  • The first type of market is the primary markets, also called gateway markets. These are located in several well-known cities and include Manhattan, Los Angeles, Chicago, Dallas, Atlanta, Boston, San Francisco, and Phoenix.

Primary markets are considered lower risk than other markets, as they are less volatile than secondary and tertiary markets.

  • Secondary markets are experiencing a boom in the market right now as urbanization, the growth of small tech businesses and startups combine together to make low prices and better availability of the commercial property in these attractive cities.

3 Types Of Investment Properties

Types of commercial property

Once you decide where you’d like to buy an investment property, the next step is to decide what type of investment you’d like to purchase. These are segments that are defined by the risk vs return of each type.

1. Core And Core Plus Investments

These properties are considered to be stable, secure investments that are the least risky. They include properties with investment grade tenants, Class A buildings, and are located in successful locations. As Class A buildings they are in top-notch condition and offer superior design, state of the art amenities, and are LEEDS certified.

Because these properties are in top condition and have low vacancies they do not appreciate much in value. In comparison to investments such as stocks or bonds, they provide a safe, predictable cash flow. In a case when the investor does choose to sell a core property, their value makes them easy to sell at a profit. Triple net lease properties are a good example of these kinds of properties.

2. Value Add Properties – Commercial Real Estate Investments

Value-add properties are riskier than core properties but offer the possibility of greater profits. This is done by renovating or re-purposing the commercial property so that greater value can be obtained. Investors who choose to invest in value-add properties carefully examine the property to determine how they can increase the cash flow as quickly and inexpensively as possible.

Some examples of value-add improvements include:

  1. Cosmetic improvements that update the building and increase appeal to higher quality tenants
  2. Improving management
  3. Lowering expenses
  4. Raising rent to market rates

Once the investor has successfully increased the cash flow of a value-add property they may either hold the property long-term or sell it in order to capture the increased equity. This equity can then, in turn, be used as leverage on a new commercial property.

3. Opportunistic Real Estate Investments

opportunistic real estate investments

The last category of investment types is opportunistic properties.

At the other end of the scale in terms of risk, these properties are typically fully vacant or are a raw land where the investor intends on constructing a totally new property. Since there is little or no cash flow, investors must create a plan for increasing equity that is often based on factors difficult to predict or beyond their control.

For the same reason, financing for these projects can be difficult, unless the commercial property is owned by a group of investors, or the investor is well-known and relying on lenders who are familiar with his track record of successful past projects.

On the other hand, opportunistic properties present the highest returns for investors willing to take the risk.

Investors new to commercial real estate should start with core investments and work their way down the spectrum. If finances are an issue, a savvy investor might consider purchasing a commercial property in a secondary market or seek private lenders who can help fund a new project.

To Conclude

In order to find a good value-add property, you might take in mind those with trapped value (physically, economically or structurally). When finding the right commercial property it is crucial to make a business plan to increase value as well as determine the right price

Having a fluid investment capital is also a big plus, as those companies which have at their disposal more funding sources can add value by setting a financing form which fulfills the needs of the business plan.

Looking To Buy Commercial Property?

Find out why triple-net lease real estate investments should be part of your investment portfolio.