Published: Investing in Distressed Real Estate

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Types of Opportunistic Real Estate Investments

 Investors can choose among four main ways to acquire and invest in real estate. The conventional investment methods include core investments, where the investor seeks a stable income coupled with low-risk real estate development through long-term leasing and renting to recover the initial cost of the property. At low to moderate risk, a core-plus option entails an opportunity to increase cash flow through property improvements, better real estate management efficiency, or changes to acquire better quality tenants. A value-add investment includes acquiring property, followed by significant renovations before selling. Last, the opportunistic model, considered the riskiest, either develops projects from the ground up, redevelops existing property, or purchases distressed buildings for renovation or resale.

For redevelopment opportunistic real estate, investors acquire property with existing buildings for repurposing to a different use, through two methods. The first, adaptive reuse, entails converting the property to a purpose other than what it was initially designed for. For example, it could entail converting a warehouse into residential units or retail space through partitioning and re-designing the interior. Conversely, an urban infill focuses on the land rather than the buildings and repurposes the vacant land for another purpose, such as building a commercial greenhouse operation on a landfill.

New developments can also be considered opportunistic real estate projects and entail acquiring vacant land and developing property through construction from the ground up. Depending on the tenancy, the developer may opt to purpose-build the property to serve a specific purpose or tenant, like a hotel on a long-term lease or a generic design for later customization.

Unlike redevelopments, which are restricted by the previous property's construction, building from the ground up offers more flexibility in property design and adaptation to the prevailing market needs. However, new construction takes time, during which there is no cash flow, only expenses. This requires the investor to set aside enough financial resources to cover the project costs and other outlays like debt obligations.

Compared to the other opportunistic investment methods, ground-up developments harbor the highest risk for the investor, especially during the construction phase, due in part to losses associated with project delays. Bad weather may stall the construction, while seemingly minor market variables like an increase in the cost of materials or lack of labor can significantly affect the project's cost, especially for large developments. The investor requires substantial resources to absorb the delays, unexpected project costs, and other expenses before the development achieves a viable occupancy level after completion.

Last, distressed real estate focuses on acquiring property at a heavily discounted or below-market rate. The typical situations creating distressed property include foreclosures, abandonment, unwanted inheritances, and other administrative or physical issues. The investor requires due diligence and research to identify feasible projects, identify problems, and create a resolution plan. Lack of caution results in many issues, like underestimating the cost of renovations required to transform the property to a level that will attract tenants.

Also, some distressed properties feature low cash flow, either due to the state of the neighborhood, the condition of the property, a high vacancy rate, or excessive maintenance costs. In such situations, besides performing renovations, investors may have to replace current tenants with those willing to pay higher rents to generate sufficient cash flow and fulfill debt obligations.

The opportunistic model provides the best option among conventional investment strategies for investors willing to take on riskier real estate investments and do the work required. In the best-case scenario, opportunistic investments reap significantly higher returns on investment than traditional investments. To be safe, however, the investor should spread the investments across diverse properties to mitigate risk and ensure solid returns.

Published: An Overview of Commercial Real Estate Investing

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Published: Leasing vs. Owning Commercial Real Estate

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