Commercial Real Estate Investment Programs
The Relationship of Risk and Return
Commercial real estate is a tangible asset with the potential to increase in value over time. Adding commercial real estate to an investment portfolio can enhance diversification, provide a hedge against inflation, generate income, and preserve capital.
Determining what type of commercial real estate investment is best for your portfolio hinges on understanding the relationship of risk and return.
There are three primary categories of commercial real estate investment strategy, each offering certain risk and return characteristics. A balanced investment portfolio includes a mix of these three strategies.
Here is a look at the three asset categories, and an explanation of characteristics.
Core Investments
Core commercial real estate programs generally use conservative strategies for lower-risk investments. Core properties are typically well-leased and well-maintained office properties located in well-established markets. Fund managers seek core investments that have stable, highly creditworthy tenants.
Core investment programs, such as Behringer Harvard REIT I, Inc., are long-term investments. Core investments are designed to protect against inflation, and have a primary investment objective of creating income and capital preservation. Typically core investments have a long-term holding period of eight to 12 years.
Core:
- Conservative risk
- Long-term holding period (eight to 12 years)
- Objective is current income
- Example of core investment program: Behringer Harvard REIT I, Inc.
Value-Added Investments
Value-added investments offer a moderate level of risk. The goal of value-added investments is to acquire properties that need improvement or repositioning. Properties classified as value-added usually require amenity and aesthetic upgrades, or require management or operational improvements. Value-added investments usually have a short-term holding period of three to six years and focus on appreciation rather than income.
Value-Added:
- Moderate risk
- Mid-term holding period (three to six years)
- Objective is value appreciation
- Example of value-added investment program: Behringer Harvard Opportunity REIT II, Inc. (blend)
Opportunistic Investments
Opportunistic real estate investment programs assume the greatest risk of all three asset classes, but have the objective of generating higher returns. These investments generally require the investment program to convert, redevelop, or reposition an existing property in order to seek its highest and best use. Acquisitions may be concentrated in limited geographic areas. Opportunistic investments generally have a short-term holding period of three to six years, and are geared to maximize appreciation. To add value to the property, program managers may re-tenant, reposition, recapitalize, develop, or redevelop it.
Opportunistic:
- Higher risk
- Short-term holding period (three to six years)
- Objective is significant value creation
- Example of opportunistic investment program: Behringer Harvard Opportunity REIT II, Inc. (blend)
Real Estate Ownership Risks
- Absence of a public market for these securities
- Lack of an operating history
- Absence of properties identified for acquisition
- Limited transferability and lack of liquidity
- Reliance on the REIT’s advisor
- Payment of significant fees to the REIT’s advisor and its affiliates
- Potential conflicts of interest
- Incurrence of substantial debt
- Lack of diversification in property holdings until significant funds have been raised