Successful CRE value investing can provide higher returns, but sponsors must undertake contrarian strategies that include construction, redevelopment, retenanting, lease-up strategies, entitlement completion, refinancing, tenant and interest rate risks. A key component of a successful value investment CRE strategy usually includes a construction or redevelopment component and the investor must have a solid in-house expertise or working relationship with experienced contractors to complete full or partial property renovations on time and within the cost budget. Most valued added investment strategies in CRE include this redevelopment component and therefore this is critical to creating value. Most institutional investors do not have or do not want to “get their hands dirty” in a redevelopment deal and usually do not consider this type of CRE investment strategy.

CRE value investing typically includes the following strategies:

• Major or minor redevelopment of the property.
• Substantial renovation of apartment units or commercial space.
• Retenanting or repositioning a high vacancy property.
• Demolishing and rebuilding a property in which there is a higher and better use for the site.
• Expanding a property with additional units or rentable square feet
• Converting a property to a different use, i.e., office to hotel, office to hi-rise apartments, retail center to office service or office to data center.
• New management program and operational strategy that can increase current rents and occupancy.
• Developing new sources of revenue, i.e., bill tenants for water, trash and sewer, RUBS submetering program for apartments and converting commercial leases to triple net from gross or double net.
• Investing in areas or markets that are out of favor or heavily distressed, i.e., the City of Detroit and the Central Valley of California.
• Leasing the property to high credit tenants under long-term leases.
• Obtaining full entitlements for a large mixed-use development.

There are three central elements in a value investment philosophy, as detailed in the Margin of Safety book, that also applies to CRE value investors as follows:

It is a bottoms-up strategy requiring analysis of the real estate asset first, then the local market, the metropolitan statistical area (MSA), national market and finally the economy.

Value investing requires absolute performance, not relative performance. CRE value investors seek to earn higher risk-adjusted returns as compared with their own investment goals, not the returns on various indexes like NCREIF, FTSE Equity REIT Index, etc.

CRE value investing is also a risk adverse approach that requires the sponsor to evaluate not only the potential return but the risk of not achieving that return or losing all or a portion of the equity investment.

CRE value investing is a niche strategy that requires patient capital, expertise in construction and renovation and the ability to see value where others see detriment. If CRE value investing strategies are applied successfully, they can generate significant alpha returns in this competitive real estate environment.

Joseph Ori is executive managing director of Paramount Capital Corp. The views expressed here are the author's own and not that of ALM's Real Estate Media Group.