Choosing Your Real Estate Investment Strategy

Ever felt like playing Monopoly in real life?

Selecting the right real estate investment is not unlike choosing where to plant your flag in the classic board game—some choices provide steady, long-term gains, while others offer the thrilling potential of significant returns at a higher risk.

Whether you're after Park Lane or the modest Whitechapel Road, each property mirrors a real-world investment strategy with its own unique risk and reward profile.

Why Choosing the Right Strategy is Essential

Selecting the right real estate investment strategy is crucial for aligning with your financial goals, risk tolerance, and market conditions. 

By understanding the nuances of each strategy, you can tailor your approach to better align with your financial goals, market conditions, and personal risk tolerance.

To explore various real estate investment strategies, we'll use the familiar game of Monopoly as an analogy to simplify complex investment concepts.

• Core and Core-Plus Real Estate (Class A): They are like the coveted properties like Park Lane and Mayfair—prime, sought-after locations that are already well-developed, much like fully built-up properties in the game. They offer reliable, steady returns with little need for additional investment.
• Value-add Real Estate (Class B and C): This strategy is like investing in the orange and blue properties. They are in good locations but require strategic improvements, like building houses in the game, to increase their value and rent potential. 
• Opportunistic Real Estate (Undeveloped to Class A): Here, this is like buying the underdeveloped properties in less frequented areas of the Monopoly board, like the utilities or stations, and turning them into top-tier assets. It involves developing raw land or significantly repurposing existing structures, transforming them into premium Class A properties. It’s a high-risk, high-reward strategy.

Like Monopoly, real estate investors must decide when to invest, where to build, and how to upgrade their properties strategically.

This next section will dive into more details on each.

Risk vs Reward

A common way to think about real estate investing is to understand the different strategies on a risk versus-reward spectrum.

Core Real Estate

Core real estate is usually fully leased, Class A buildings in major markets like Sydney, Melbourne, or Brisbane.

Investors know these are safe investments as they have predictable income and are considered low-risk. When investors know these are safe investments, they bid up the price, so the expected returns are lower. 

This is what the majority of the REITs on the ASX invest in. 

You can find decent yields here, but not a lot of capital growth. 

Core-Plus Real Estate 

Core-plus real estate is slightly higher on the risk spectrum than core real estate.

Core-Plus real estate is often of slightly older properties than core properties and may require some physical and operational improvements needed to realise the property’s full potential. 

Value-add Real Estate 

Value-add investments refer to properties that need renovation or operational improvements to reach their full potential.

The property is already operating and generating cash flow, with the opportunity to improve it.

One of the best risk-adjusted rewards lies in development. Constructing new buildings from the ground up is challenging, and there is often less risk associated with enhancing existing structures that are already operational.

There is a spectrum of value-add from light to medium to heavy based on the total planned capital expenditure over existing value.

If a property is being purchased for $10 million and has a $2 million capital investment plan, that's 20% of the purchase price going to capital works and a heavy value-add. This might be a complete renovation of the block, including kitchens and bathrooms. 

While if the same property only requires $500k in improvements (some new paint and upgrading community space), it would be a light value-add.

Opportunistic Real Estate 

Opportunistic investments are the high-risk ones that are expected to generate the highest returns.

Opportunistic properties tend to have a long lead time and generate no cash flow in the interim but have substantial rewards at the end.

Opportunistic investments are where investors can really get burned if they don't know what they're doing.

Why are they so risky? There are lots of moving pieces, decisions to be made, and people involved. 

Property Classes

Real estate properties are also categorised into four classes: A, B, C, and D. 

Each class can also bring a different level of investment risk and reward.

These are often blended with the strategies above; for example, you could have a Core Plus strategy with an A-class property in a B-class neighbourhood.

In property syndications, much of the value creation comes from repositioning existing stock into different segments of the market.

For example, take a class C property that rents for $1,000 a week and a class B property that rents for $1,400 a week. 

Whether you're looking for stability or growth, understanding these classes and how different properties are positioned in the market is key to identifying good investment opportunities. 

Class A: Premium Real Estate

Class A properties are the cream of the crop.

These properties are often located in the most desirable neighbourhoods and have easy access to premium amenities. 

Think of them as the polished jewels of the property market, offering luxurious living or working spaces with state-of-the-art features.

Typically with no deferred maintenance, these buildings are turnkey solutions for investors looking for immediate rental income without the hassle of renovations. 

Deferred maintenance is the practice of postponing property upkeep due to budget cuts or strategic choices, potentially leading to higher long-term repair costs and diminishing asset conditions.

In contrast, Class A properties represent the highest quality real estate in prime locations with top amenities and typically require no deferred maintenance, providing investors with turnkey solutions for immediate rental income without renovation concerns.

However, this perfection comes with a caveat: the limited scope for value-add strategies. 

Since these properties are already at the top of their game, the room for enhancing their value or increasing rent is minimal. 

Many syndications of newer real estate assets have been passed on because, although the general partner believed significant value could be added, there is often not a lot of scope to do so in Class A products.

Instead, the appeal lies in the predictable cash flow and the relatively lower risk of vacancy or tenant turnover, making them a safe harbour in turbulent economic times.

For this reason, investors drawn to Class A properties are typically institutional or risk-averse individuals who value stability over high returns. 

Class B: Balanced Opportunity

Class B properties offer a compelling balance between quality and opportunity for improvement. 

Typically built within the last 20 to 40 years, these buildings are nestled in nice areas and in proximity to amenities like parks and shopping centres.

The charm of Class B properties lies in their potential. 

Positioned in the upper-middle segments of the market, they command decent rents but also present opportunities for savvy investors to implement value-add strategies. 

By upgrading amenities, refreshing interiors, or improving property management, investors can significantly enhance the property's appeal, boost occupancy rates, and increase rental income.

Class C: Renovation Ready

Class C properties are the fixer-uppers.

These older buildings, often 30 years of age or older, are prime candidates for renovation and repositioning in the market.

They may lack curb appeal and feature outdated elements like older appliances and design aesthetics, but herein lies the opportunity.

Investing in Class C properties is about seeing beyond the surface.

The goal is to elevate them to Class B or even A standards, unlocking significant value in the process.

This class attracts investors who are hands-on and willing to tackle deferred maintenance and cosmetic updates to transform a property's fortunes.

Class D: High Management

Class D properties are properties with the lowest quality.

These are run-down buildings in less desirable neighbourhoods, often plagued by significant deferred maintenance issues and a problematic tenant base. 

Investing in Class D properties is not for the faint-hearted; it requires experience, a solid strategy for dealing with tenant issues, and a comprehensive plan for property rehabilitation.

The allure lies in their potential for dramatic transformation and outsized returns.

However, investors must be prepared for the challenges of extensive renovations and higher vacancy rates.

Investment Strategies

Real estate offers a number of different paths to investment, each with its own unique mix of involvement, risk, and return. 

Among these, three popular methods stand out due to their distinct approaches and potential benefits: ‘Buy and Hold’, ‘Fix and Flip’, and development. 

Most indications are fixing flips and developments because investors typically want a higher return and their money back in a reasonable timeframe.

Understanding these strategies is essential for investors aiming to diversify their portfolios or specialise in a particular niche.

Buy and Hold

The ‘Buy and Hold’ strategy is exactly what it sounds like: investors purchase property and hold onto it for an extended period, often indefinitely. 

This approach is grounded in the belief that real estate values will, given enough time, always appreciate.

As such, these properties can become valuable assets passed down through generations, offering long-term stability and wealth accumulation.

One of the key advantages of the ‘Buy and Hold’ strategy is its resilience to short-term market fluctuations.

Since the investment isn't predicated on immediate returns, investors can weather downturns with the expectation of eventual recovery and growth.

Furthermore, once a property is fully paid off, it becomes a source of consistent income with minimal risk, provided it's well-maintained and in a desirable location.

However, the ‘Buy and Hold’ method is not without its drawbacks. 

Capital tied up in a property is capital that's not being actively leveraged for higher returns elsewhere.

For investors seeking more dynamic growth opportunities, this strategy may seem inefficient, as it requires patience and a long-term perspective.

Fix and Flip

Contrasting with the patience required for ‘Buy and Hold’, the ‘Fix and Flip’ strategy is all about speed and transformation. 

Investors identify undervalued properties in need of renovation, invest in repairs and improvements, and sell them at a higher price.

The goal is to force appreciation of the asset, thereby maximising the velocity of capital—how quickly investment capital can be turned around for profit.

‘Fix and Flip’ is particularly appealing for those entering the real estate investment arena.

With the right leverage, a successful flip can double or even triple equity, offering substantial returns in a relatively short time frame. 

This strategy is somewhat Limited in Australia due to the presence of stamp duty, with states taking 5% every time the property changes hands.

This means to ‘Fix and Flip’ quickly, there needs to be a lot of value created or unlocked during that time period to more than account for the returns drag from the stamp duty.

This strategy requires a keen eye for potential, a thorough understanding of renovation costs, and the ability to execute projects efficiently.

While ‘Fix and Flip’ can be highly rewarding, it also involves risk, requiring hard work, market knowledge, and sometimes a bit of luck to navigate successfully.

Development

At the pinnacle of real estate difficulty and returns is a new development. 

This approach involves building new properties from the ground up, offering the potential for significant returns by creating something entirely new.

Developers purchase land, design buildings, navigate zoning laws and regulations, and manage construction projects, all with the aim of selling or leasing the finished product.

Development is a complex, high-risk strategy that demands a comprehensive skill set, including market analysis, project management, and a deep understanding of regulatory processes. 

Paths to investment

So now that we're clear on the strategies, let's talk about the most common ways of getting involved, including Direct real estate investment, REITs, syndications, and funds.

Direct Real Estate Investment

One way to invest in property is through direct investment. 

This is when you purchase a building for your own use or to lease out to another party. 

Direct ownership requires active management. The owner is responsible for all decision-making and, therefore, needs to be well-versed in buying and operating properties before going down this path.

Direct investment works really well when buying single-family rentals or apartments, but is not a good bet when looking at bigger properties that require full-time management teams, skills, and experience.

Real Estate Investment Trusts

Real estate investment trusts, or REITs, are entities that own and manage properties, offering shares to investors similar to how one might invest in major corporations like BHP or Commonwealth Bank.

These trusts often focus on specific property sectors, clarifying investment decisions for portfolio inclusion.

A critical metric in this domain is WALE, or Weighted Average Lease Expiry.

It calculates the average time until all leases in a property or portfolio will lapse, considering the income each lease contributes.

This weighted approach gives investors a nuanced view of their investment's stability and future income stream.

REITs are attractive to those who want exposure to real estate and to preserve their liquidity. This is because REIT shares can be purchased and sold just as easily as other stocks. 

The REIT structure requires the distribution of a significant portion of taxable income to shareholders, with yields primarily driven by the stable rental income generated from long-term leases, often with built-in rental escalations. 

Stapled REITs

On the ASX, a distinct investment structure we have is known as 'stapled securities'. 

Stapled REITs are when two or more different financial instruments are legally joined to function as a single entity. 

The concept of stapling involves binding a share in a company with a unit in an investment trust, creating an investment relationship between the two. 

The two things to know are:

1. The property trust handles the ownership and management of physical properties, generating rental income;
2. The management company oversees the operational aspects and generates fees from doing so.

Stapled REITs emerged from investors wanting exposure to both the underlying investment trust and corporate growth, and the entities themselves benefit from a more stable and diversified investment base. 

Real Estate Syndications

Real estate syndications are a form of investment where a General Partner identifies a specific property or properties and raises capital from private investors to acquire those assets, who then own the real estate directly alongside the General Partner.

We cover syndications more in depth in this article, but for now, the key thing to know is that syndications offer investors the opportunity to be part of a specific real estate venture, where the details of the property, including its location and potential for improvement, are known upfront.

This means that you review specific deals and select opportunities without blindly investing money in a fund that has a bunch of stuff in it or that will add stuff in the future that they don't know about yet.

A syndication can be a single asset or a pooled group of assets.

Typically, investors like to know what they are buying, so syndications are more common and easier to market than funds.

Real Estate Funds 

Funds have some similarities to syndications but are ultimately a different investment. 

A real estate fund aggregates capital from individual investors to make a variety of investments.

These funds often have predefined parameters, such as a focus on shopping centres in NSW. 

Predetermined limitations on fundraising, the deployment of funds, amounts of leverage, and fund life are set forth to provide investors with some comfort in knowing how their money will be invested.

What makes a fund different from syndicates is that investors and assets can come in and out at different times. 

This makes them very complex operationally, both from a logistics and accounting perspective, so real estate funds tend to be a lot bigger than syndications to make them worthwhile.

Unlike real estate syndications, investors in a fund may not know the exact properties that will be purchased.

The fund might have pre-identified properties, but often investors commit their capital without specific knowledge of each investment. 

Real estate funds offer diversification and professional management, allowing investors to participate in a broader range of real estate opportunities without the need for detailed knowledge of each property.

Conclusion

Choosing the right real estate investment strategy involves careful consideration of market conditions, personal financial goals, and risk tolerance.

If you’re looking to take the next step in your investment journey, and receive updates on the latest trends and openings in the Australian property market, sign up for your mailing list here.