If you want to break into a career with a real estate private equity firm, you have to commit to a great deal of preparation. To stand out from the host of applicants from target schools, you must demonstrate that you know more and will work harder than anyone else. Understanding what makes a REPE firm tick means understanding types of private equity strategies, as well as types of private equity fund structures.
What is an investment strategy? An investment strategy is understood through the types of properties, the markets, and the risk level. The strategy may be an overarching theme that defines all of the deals the firm pursues, or it may be specific to one particular fund. These strategies universally apply to real estate private equity all over the world. There are four investment strategies: Core, Core Plus, Value-Add, and Opportunistic.
Core real estate investments contain the lowest risk and thus the lowest return. Core assets are fully occupied, exhibit excellent physical condition with no deferred maintenance, achieve market rents, attract high-credit tenants, and are located in primary markets such as New York, Los Angeles, Chicago, San Francisco, London, Paris, etc. Generally, there is no expectation of appreciation and performance will be predicated solely upon rental income. Rates of return are typically in the 7-9% range, and minimal leverage (less than 40%) is common among core investment funds. Elite properties within the Core classification are sometimes referred to as “trophy” assets, meaning ownership is a privilege in itself.
Core Plus is similar to Core, but has some opportunities to increase Net Operating Income (NOI) and therefore generate some appreciation in the value of the property. A property may have tenants with a lease expiring in the next few years, and the opportunity to replace that tenant with one paying higher rent in the future. Or, the property may include a tenant with a lesser credit profile that could be replaced with better quality occupants, thus improving NOI. Core Plus real estate could also include properties that meet the credit quality and condition of a Core asset, but is located in a smaller market (Dallas, Atlanta, Phoenix, Minneapolis, etc.). Returns range from 8-11%, and leverage may be slightly higher as well (40-60%).
Value-add properties present investors with higher opportunities for returns (12-15%), but that comes with more risk. Often times, a value-add play will involve acquiring a property with significant vacancy (greater than 20%) with plans to re-tenant, or it could involve a redevelopment of the property such as tearing down part of a shopping mall to build apartments or turning a former warehouse into an office building. Value-add investors also tend to issue more leverage (60-70%), helping to boost returns.
Deals that fall into the Opportunistic bucket are often ground-up development. These projects feature a much higher risk profile because of the complexity in bringing them to completion. Entitlements, construction, leasing, and capitalizing are all significant risk factors with opportunistic projects, and as a result the returns are usually 20% or better. Leverage may climb as high as 80-90%. Such high leverage often involves some type of mezzanine financing to fill the gap between bank financing and equity.
If you are seeking a career with a real estate private equity firm, knowing the types of investment strategies the firm employs before you walk into an interview is smart. Understanding the types of private equity fund structures they utilize will really blow them away! Demonstrating that you have researched their fund offerings and can explain the how, why, and where of their portfolios will help you stand out in the interviewer’s mind. Once you’ve landed the job, investment strategies keep you focused so you spend your time on deals that fit the funds.