I have the honor of being an Adjunct Professor at the NYU Schack Institute of Real Estate where I teach the occasional course. An outstanding textbook we utilize was written by Dr. Peter Linneman, a distinguished professor at the Wharton School of Business, and one of his lessons is summarized in the nearby chart.

Linneman models four investments in the following asset vehicles:  Core, Core Plus, REIT and Value-add. Each of the four investments has equal capital outlays, NOI growth rates and exit cap rates. Linneman forecasts the returns for each investment by modeling Base, Strong, Weak and Disaster real estate market scenarios.

A key conclusion, Linneman writes, is that “in all cases, the Value-add fund yields the highest IRR, while the Core strategy (NCREIF) yields the lowest in all but the Disaster scenario.”

A pivotal assumption in Linneman’s model is that the value-add property is purchased at sensible valuation and that the asset achieves stabilization. If you pay too much, or the asset fails to deliver, the value-add scenario is not the winner.

As I have written previously, now is the time to focus on buying value-add assets with comparatively high cap rates, as this is in many ways the defensive play. Forget the Wall Street herd clamoring to buy multifamily assets in select cities at cap rates below 5%.  When interest rates increase and cap rates rise during the hold period, these low-cap investments will flounder. In contrast, the investments you make this year in secondary cities with reasonable cap rates will maintain their value.