Trustcapital Real Estate Team
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If you’re a real estate investor seeking high-risk, high-return opportunities, opportunistic investing might align with your investment objectives.
In this article, we will explore the concept of opportunistic real estate investments, discuss their distinctive features, provide examples of projects, and offer insights on how to find these investment opportunities
What are Opportunistic Real Estate Investments?
Situated at the highest level of risk and potential return, opportunistic investments typically involve land development, ground-up development, or repurposing existing assets. These highly complex projects require significant time and financial commitments and are typically pursued by experienced real estate sponsors and developers.
For example, ground-up projects normally take at least 3 to 5+ years to complete with thousands of moving pieces or things that might not turn out as planned. During that time, the site is generally not earning any income that can be used to offset the carrying operating expenses—including but not limited to property taxes, insurance, and debt service. Most opportunistic deals are acquired with between 50% to 70% leverage depending on whether they are a land deal or anticipated conversion.
In addition to carrying costs, the owner will likely be fronting the cost for architects, engineers, permitting consultants, attorneys, and other third parties needed to bring their vision to fruition.
These costs add up. Opportunistic deals can often cost the owner tens of millions of dollars before they receive a single cent in income. As such, opportunistic real estate deals are typically only pursued by highly sophisticated real estate sponsors and developers with years of experience under their belts.
How Do Opportunistic Investments Differ from other real estate investment strategies?
Commercial real estate investors use the term “opportunistic” loosely. They’ll refer to the opportunistic strategies they use to acquire undervalued properties that need varying degrees of physical improvements.
In most cases, the owner is likely referencing Value Add or Core Plus real estate. In other words, the owner sees an opportunity to improve and create more consistent cash flow—which is decidedly different from what’s technically considered an opportunistic real estate investment
Here is a look at the differences between Core, Core Plus, Value-Add, and Opportunistic Properties
Core real estate is usually a fully stabilized, Class A building in a strong market with a growing economy. Core investments tend to have predictable income and are considered low risk. Private equity firms often own core properties.
Core-Plus Real Estate
These include older properties located in primary markets, as well as Class A/B properties located in secondary and tertiary markets. Core-Plus real estate is often of a slightly older vintage than Core properties and may require slight physical and operational improvements needed to realize the property’s full potential. Core-Plus properties are usually low to moderate-risk investments.
Value Add Real Estate
Value add investments refer to properties that need substantial renovation or operational improvements to stabilize at or above local market rents.
A “light” value-add strategy might involve refreshing each apartment unit with new paint, carpet and fixtures and replacing the management company with one that’s more professional and aggressive about rent collections.
A “heavy” value-add strategy could include gutting a property to the studs, reconfiguring the units, and upgrading the building systems and façade. However, even heavy value-add strategies assume the property types remain as-is, and no use change is required.
Learn more: Is value-add a good investment?
Opportunistic Real Estate
Opportunistic investments include both ground-up construction on undeveloped land as well as a major overhaul of an existing structure that is changed or repurposed from one property type to another.
Opportunistic properties tend to have a long-lead time and generate no cash flow in the interim. Opportunistic real estate investments are very high risk and should only be contemplated by experienced real estate sponsors and developers.
Why Opportunistic Real Estate Investments emerge?
A strategy of opportunistic real estate is a strategy that capitalizes on market conditions and changes to achieve higher returns.
For example, demand for ground up development is normally driven as cities expand and urbanization continues, which can create a shortage of affordable housing options to accommodate the growing population. Booming cities attract businesses, job opportunities, and a surge in population, creating a high demand for housing. In such cases, opportunistic real estate investors can identify opportunities to develop new residential properties to meet the housing needs of the expanding urban population.
Austin, Texas, serves as an example of a city where new real estate development emerged to meet housing needs during a period of rapid growth. The city experienced a surge in population due to factors like the booming tech sector and a favorable business environment. This led to a shortage of affordable housing options.
Opportunistic real estate investors seized the opportunity by acquiring land in strategic locations and initiating ground-up development projects. They transformed underutilized properties into modern residential communities, helping address the housing shortage and accommodate the growing population. These investments contributed to the city’s economic growth with the city rapidly becoming a technology and manufacturing hub.
Similary, rapid changes in renter preferences, advancements in technology, or unexpected events (such as the pandemic) can render certain property types or locations obsolete. A property that was once thriving as an office space, for instance, may suddenly face challenges due to the accelerated shift towards remote work. In such cases, opportunistic investors can seize the opportunity to repurpose the property into a mixed-use development or multifamily asset, generating substantial returns through strategic repositioning.
Similarly, shifts in capital markets can create distress or distress-like situations for property owners. Unforeseen rises in interest rates or changes in lending conditions can disrupt financing plans and put pressure on property owners who relied heavily on debt or anticipated refinancing at specific rates. Such scenarios provide opportunities for opportunistic investors to step in and capitalize on distressed situations, acquiring assets at lower-than-anticipated acquisition bases and unlocking value through strategic management and repositioning.
The Role of Leverage in Opportunistic Real Estate
Leverage plays a significant role in determining the risk profile of a real estate investment. It is important to understand how different investment strategies utilize leverage and how it affects the overall risk and potential returns.
For example, opportunistic investments often employ higher leverage, sometimes exceeding 70% or more, as these projects require substantial upfront capital. However, it’s important to note that the availability of debt may vary depending on the specific project. In contrast, core investments typically utilize lower leverage, around 40-45%, to maintain stability and minimize financial risk.
While higher leverage can magnify potential returns, it also increases the exposure to financial risk – so It’s crucial for investors to assess their risk tolerance and ensure that the chosen investment aligns with their comfort level. It’s worth noting that excessive leverage can be detrimental, especially during market downturns, as it can lead to challenges in meeting debt obligations or even foreclosure in severe cases.
The Importance of Developer Experience
When considering opportunistic real estate investments, one of the crucial factors to evaluate is the experience and track record of the sponsor or developer. Successful execution of opportunistic strategies demands a deep understanding of the intricacies involved, as well as the ability to navigate complex and challenging projects.
Investors should prioritize sponsors or developers who have a proven track record of success with similarly opportunistic investments. This experience indicates their ability to handle the unique demands and risks associated with such projects. Look for sponsors who have demonstrated expertise in the specific business strategy, property type, and market in which they are operating.
Opportunistic Real Estate Examples
Opportunistic real estate investing can usually take three forms:
- Land development
- Ground-up development (or redevelopment)
- Changing a building’s use
Given these different avenues, generally, different locations bring opportunities for different projects. For example, an opportunistic development in a new city might be a ground-up apartment development – while in an existing city, repositioning an office building into apartments might be a more common project.