Prior to investing in a commercial or residential property, it is important to understand how to evaluate the investment. Investors need to determine their risk tolerance as to whether they are better suited to invest in stabilized or unstabilized real estate assets.
For a property to be considered stabilized, it must have the following characteristics:
- The property is fully leased or leased to the market occupancy
- Property rents are at market rates
- Tenant turnover is minimal in the short term and is staggered over the long term
- The property requires minimal capital improvements to maintain present operating standards
Many investors choose to begin with stabilized real estate assets with thepossibility there could be a long term upward potential for growth; however, these properties are purchased primarily for the consistent and steadied cash stream. Upon investing in a real estate asset, there is comfort knowing that there will be consistent cash flow expected from the property. Stabilized properties tend to be for investors who want to minimize uncertainty and risk exposure in their real estate portfolio. The safest real estate assets have the following features:
- Macro location – a large, lively market
- Micro location – well positioned within the submarket
- Newer construction or well maintained
- Tenants – excellent tenant credit quality with long term leases
Alternatively, unstabilized properties are usually real estate assets that require major renovations, have high expense ratios, below market rents, and/have higher than market vacancy rates. Unstabilized properties are attractive to investors because the real estate asset is usually listed and able to be purchased well below stablized market value. The investor is also confident the property can be transformed through a value-add play into a stabilized property by fixing the aforementioned issues thereby increasing net operating income (NOI). NOI can be increased most commonly through renovations, which in term attracts better quality tenants with higher market rents and longer term leases.
Investing in both stabilized and value-add real estate assets will provide you with a diversified portfolio and a greater probability of high returns with stable cash flow income. However, whether you choose to invest in a stabilized or unstabilized real estate asset or both, it is important to ensure the investment suits your needs, risk tolerance and investment return expectations.