Stabilized or Value-Add Investments: Which Strategy Is Right For You?

In this blog, we delve into the core distinctions between two principal investment strategies. We explore the foundational strategies, assess the balance of risk and return, and provide return metrics that illustrate the nuances of investing in stabilized versus value-add commercial real estate. Whether you’re an experienced investor aiming to broaden your portfolio or a novice exploring the complexities of real estate investing, this piece acts as a detailed guide, helping you navigate your commercial real estate investments with clarity and sophistication.

What Are Stabilized Investments?

Stabilized investment properties have both occupancy (typically around 85%+) and lease terms at levels that allow a new owner to acquire the asset and receive substantial net cash flow without making any substantial contributions to the property.

The hallmark of stabilized properties is consistent and predictable cash flow, often with long-term tenants in place. This stability can make these investments particularly attractive to those seeking a low-risk profile and steady returns, mirroring the characteristics of a fixed-income investment with added inflation protection.

What are Value-Add Investments?

On the other hand, value-add investments represent developments and strategies that focus on substantially increasing the net operating income (NOI) of a property. This can be achieved through various operational enhancements, such as upgrading building systems, renovating units, or revamping management practices to improve efficiency. The goal is to transition a property from a lower income-producing class to a higher one over time, thereby increasing its value.

Value-add approaches require a more involved and strategic investment approach, often with a shorter-term horizon. Investors with the appetite for more hands-on management and the willingness to accept a higher level of risk for higher potential returns are typically drawn to this category.

Comparing Investment Strategies

Stabilized
Investing in stabilized properties typically involves a conservative, hands-off approach. It often necessitates paying a premium for the property due to its income-generating stability. The key focus here is on long-term wealth preservation and steady, passive income.

Stabilized assets can be located in any established market with solid fundamentals, and offer little room for significant value appreciation but provide a consistent, lower-risk income stream. Investors in this category prioritize wealth preservation over aggressive growth.

Value-Add
Value-add investment strategies are built on identifying and unlocking unrealized potential in underperforming or mismanaged assets. This approach involves a more hands-on, active role in the investment process, often entailing higher initial investment risks in exchange for the possibility of achieving substantial returns. Investors in this category are typically more growth-oriented and have a shorter investment horizon, aiming to optimize property performance before potentially revisiting their portfolio strategy.

Assessing Risk and Return

Stabilized
Stabilized investments offer a lower-risk proposition. The properties are operational, with established cash flow streams, stable tenant profiles, and little need for capital expenditures in the immediate term.

The return on stabilized investments is usually modest but consistent, reflective of the lower risk. These investments provide a reliable income that tends to outpace inflation over the long term, making them a sound choice for those seeking a secure fixed-income alternative within real estate.

Investors can typically expect returns to be in the following ranges for multi-tenant properties on a ten-year hold: 6-8% cash-on-cash, 12-15% IRR.

CHI Memorial Medical Office Building Chattanooga

Value-Add
Value-add investments come with a higher degree of uncertainty but offer the potential for significantly higher returns. They are characterized by the injection of capital and hands-on strategy to enhance property performance, which can result in increased rental income and property appreciation.

Returns on value-add investments are derived from a combination of operational improvements and market appreciation. While the cash flow during the investment period may vary and be initially lower, investors reap the rewards upon successful implementation of their strategy, often achieving a higher return compared to stabilized assets.

Investors can typically expect returns to be in the following ranges on a three to five year hold: 3-7% cash-on-cash, 17-20%+ IRR.

Southrail Business Park Charleston

Takeaway

Balancing the allure of high-growth opportunities with the appeal of secured cash flows is a fundamental consideration for any real estate investor. Stabilized and value-add investment strategies offer distinct paths to commercial real estate success, each with its own set of benefits and complexities. For the investor, the decision to pursue a stabilized or value-add approach hinges on individual goals, investment horizons, and risk tolerances.
In the end, the art of real estate investment lies in recognizing which strategy aligns with your resources and objectives, and capitalizing on the opportunities that present the greatest potential for realizing your vision of financial success in the dynamic landscape of commercial real estate.

At Excelsior, we have experience with both stabilized and value-add investments and would be happy to provide more information on current investment opportunities we’re targeting. Feel free to reach out to our team here to set up a call to learn more.