Understanding the relationship between risk and return is crucial when making investment decisions. Almost every investment aims to generate an expected return, whether it's through regular income, an increase in the investment's value over time, or a combination of both.

However, the basic principle is that higher potential returns usually come with a higher level of risk. How much risk an investor is willing to take varies from person to person and depends on various factors. Some of these factors include the composition of their existing investment portfolio, when they may need the invested funds, their retirement plans, and potential income from other sources.

Regardless of an individual's comfort with risk, it's important to grasp the relationship between risk and return for any potential investment. This understanding ensures that the investment aligns with the investor's personal goals and objectives. Commercial real estate investments, in particular, can be classified into four main risk-return categories:

1. Core: These investments are considered relatively stable and low-risk, offering steady income streams and modest appreciation potential.
2. Core-Plus: These investments offer slightly higher returns than core investments but also involve a slightly higher level of risk. They may have some potential for increasing value over time.
3. Value-Add: These investments involve a higher degree of risk but offer the potential for greater returns. They often require active management and improvement efforts to enhance the property's value.
4. Opportunistic: These investments carry the highest level of risk but also offer the potential for the highest returns. They typically involve significant renovations, repositioning, or development projects that aim to maximize the property's value.

By understanding these risk-return profiles, investors can make informed decisions that suit their individual preferences and financial objectives.

Core

Core properties are the safest and most conservative type of investment. They have the lowest level of risk and the lowest potential for high returns. These properties are considered stable and reliable, offering investors predictable earnings.

Core properties typically have stable occupancy rates, reliable tenants with good credit, long lease terms, and prime locations. They usually don't require immediate repairs or renovations.

When it comes to financing, core properties have many options available, assuming the borrower meets the necessary requirements. They provide a relatively high level of income security, meaning that investors can expect a consistent stream of income from these properties. However, there is limited opportunity to increase the investment's returns in the short term.

In terms of appreciation, core properties generally experience slow to moderate growth in value over time. Investors who choose core properties usually plan to hold onto them for a longer period, often ten years or more.

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Core Plus

Core-Plus properties are similar to core properties, but they carry slightly more risk and have the potential for higher returns. The increased risk comes from opportunities to boost the property's net operating income (NOI). This could happen when a lease is about to expire or when there's a small amount of vacant space that can be filled. Core-Plus properties require minimal capital improvements and are considered a relatively safe investment with moderate to low risk.

Compared to core properties, Core-Plus properties may initially provide lower yields. However, they offer the possibility of increasing yields to some extent in the short to medium term. This can result in moderate appreciation of the property's value over time.

Similar to core properties, Core-Plus properties can usually secure financing easily in normal market conditions. Investors typically hold onto these properties for a medium to longer term, typically around seven to 10 years.

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Value-Add

Value-add properties are investments that have a medium to high level of risk, but they also have the potential for medium to high returns. These properties offer opportunities for improvement, either by making physical changes or by improving how they are operated. Value-add properties might have lower occupancy or rental rates compared to the rest of the market, or they may need significant renovations to attract and keep tenants.

While value-add properties can have greater potential for growth and increasing in value over time, they may not provide as much immediate income security as core and core-plus investments. It may be more challenging to secure financing for value-add properties because they are considered riskier, which means they could have higher interest rates and shorter loan terms. Typically, investors hold value-add properties for a relatively short to medium period of time, usually three to seven years.

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Opportunistic

Opportunistic properties are the riskiest type of investment but also have the highest potential for big returns. These properties typically require significant improvements or changes to make them profitable. Examples of opportunistic properties include new construction projects, converting old buildings for new uses, dealing with complex legal situations like bankruptcy or foreclosure, or investing in unique property types or emerging markets.

Investing in opportunistic properties may initially result in low or even negative yields, meaning the investment may not generate immediate income. It often requires a significant amount of money to be invested over the holding period to make the property profitable. However, the overall returns for this type of investment have the potential to be very high, although the majority of the returns may come towards the end of the investment period.

Securing financing for an opportunistic investment can be challenging and depends on the specific business plan for the property and the track record of the investor or operator. Opportunistic investments are typically held for a shorter period, ranging from one to five years.

Before investing in real estate, individuals should carefully assess their own risk tolerance, including their ability to handle potential losses. They should also consider their desired investment timeframe and the amount of time and effort they are willing to dedicate to managing the property or investment.

If you're interested in real estate investments, you can explore our Marketplace where you'll find a variety of investment opportunities that qualify for 1031 exchanges. Most of these offerings fall within the "Core" and "Core-Plus" risk profiles, which are generally considered less risky.

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