There are myriad types of investments within the real estate asset class. Multifamily is one of these asset types, and the class of choice at Park Row Equity Partners. Furthermore, within multifamily there are various investment strategies – Core, Core Plus, Value-Add, Opportunistic, and Development. The fundamentals behind what differentiates these strategies can be summed up by the popular investment cliche, “high-risk high-reward, low-risk low-reward”.
Let’s start with the lowest level of risk and move upwards. The Core strategy focuses on acquiring new builds, or no more than a decade old high-quality stabilized assets, in prime locations (think: most cities with an NFL team). These types of properties will usually have minimal to no structural issues, as well as reliable/paying tenants. There is less that can go wrong at these properties, which is why they are likely to produce an IRR return of approximately 8% to 12%. These properties are typically purchased by institutional investors looking for very steady returns.
Moving up on the risk scale leads us to the Core Plus strategy. This is very similar to Core, but the property might be a 10+ yr old vintage, lack certain amenities, or be located outside of the heart of the city (think within a one hour drive of a major domestic airport). These properties are also generally purchased by institutional investors, but might also be looked at by private real estate firms. Because there is slightly more risk involved, such as less foot traffic for leases or the need to modify amenities, these investments will offer IRR returns in the 12% to15% range.
Next comes Value-Add; our preferred investment strategy at PREP, and what is known as the middle of the road option, which yields higher returns for moderate risk. The investor acquires an underperforming or outdated multifamily property and improves it through renovations, operational efficiencies, and/or better management. Common upgrades include unit renovations, curb appeal improvements, and better tenant screening. The properties have amenities, but they’re not necessarily state of the art. The properties are generally 25+ years old, and the enhancements lead to higher rental income and increased property value. Operators need to be more dialed-in to the markets than in the above strategies, and the IRR returns generated are often somewhere between 14% and 20%.
Opportunistic is similar to Value-Add, but these investments usually come with more challenges, such as lower occupancy, higher bad debt, or major maintenance demands, and the operators are often tasked with “turning the ship around”. There usually is not any cash flow in the first few years so that the funds can be used to revamp the asset. When the operator sells the property, the IRR returns will likely be 18% or higher.
Lastly, we have Development, where there is nothing but a plot of land, and the operator has to do everything from designing, building, leasing, and then selling. There certainly is no cash flow until it is leased up, but at that point the developer will look to sell to investors looking for Core deals and generate an IRR of 25%+.
These are the five main strategies that a multifamily real estate investor may come across when being presented with a business plan for an investment property. Surely, there is overlap between the strategies and the projected returns. There is, arguably, money to be made within each of these strategies, but PREP most often leverages the Value-Add approach because it gives us the ability and control to commit resources and manpower to mitigate risk, and thus project the highest returns for a low level of risk.
