“Value-add” is all the rage, especially among newbie investors who just learned the term at their first real estate seminar.
Stabilized assets seem to be the red-headed stepchild of the real estate world … which is strange, considering that they have sat at the core of some of the most respected investment portfolios in the world. In fact, “core asset” is another term for high-end, stabilized real estate.
So why the obsession with “value-add?” Dollar signs in the eyes. Yes, value-add real estate can produce higher yields. Who wouldn’t want to double their money in five years?
So we have a classic red ocean — a feeding frenzy of investors at various skill levels, fighting over assets in that value-add sweet spot.
We come with a message from calmer waters — there’s a reason stabilized assets have been perennially popular. If you have been frustrated by the search for the perfect value-add opportunity, maybe the humble core asset is worth a second look.
First, a brief reminder of the difference between stabilized assets vs. “value-add” plays:
- Over 90% occupancy
- Close to market rents
- Little deferred maintenance or need for major improvements
- Less than 90% occupancy
- Below-market rents
- Significant deferred maintenance and need for improvements
Got it? Then let’s look at four reasons to consider stabilized assets over value-add assets.
1. Less Risk
Yes, value-added plays carry greater potential yields … but that potential comes with greater risk. The chance you could lose everything is very real, more real than most deal sponsors want to let on.
If construction and renovations run over, you overestimate your potential for revenue increase, fail to refinance, or if any number of things go wrong, those big yields could turn into total losses.
With stabilized real estate, by contrast, there’s much less that can go wrong. It’s already performing well and eligible for top financing, which gives you a lot more room to absorb the unexpected. It’s stable, so there’s less risk.
2. Cash Flow on Day One
Because of its higher occupancy and market rents, a stabilized property usually produces cash flow dividends right away. Furthermore, with less deferred maintenance you have a reduced risk that a system failure will create a cash flow crisis.
3. Greater Liquidity
Shares of stabilized real estate enjoy greater liquidity, with more demand on the secondary market. If you need to liquidate your position on short notice, you are much more likely to find a buyer for a stabilized position than a value-add position.
4. Potential for Upside
Finally, for all the hoopla about the greater yield potential of value-add real estate, stabilized assets usually also have some upside potential. You may be able to increase the property value by reducing expenses and a stabilized property will benefit from momentum in the market just as much as — if not more than — value-add real estate.
Despite the popularity of value-add assets in the real estate marketplace, it sometimes pays to go against the grain.
Not only will you find less competition for stabilized assets — but also you might even fall in love with the reduced risk, immediate cash flows, and even upside potential that other investors have missed.