The Lifecycle of a Commercial Real Estate Asset: Acquisition, Value-Add, and Stabilization

What are the various phases of a commercial real estate investment? At Cadre, we think of our assets as progressing through three distinct phases, which together make up the asset lifecycle. Both new and seasoned real estate investors can benefit from a clear understanding of the asset lifecycle, as each phase is characterized by unique objectives, risks, and rewards.

We’ll walk through a typical asset lifecycle, covering the acquisition, value-add, and stabilization phases. We’ll also discuss evaluating the decision to exit. With this information, you can better identify the risk-return profile and phase in an asset’s lifecycle that most closely aligns with your goals.

The Lifecycle of a Commercial Real Estate Asset

Phase one: Acquisition

The first step involves acquiring an asset. At Cadre, other than select development projects, we acquire existing properties. (Other investors may decide to develop a brand-new building on a vacant piece of land, a process known as ground-up development.) We evaluate commercial real estate investments by building a comprehensive understanding of market dynamics, historical performance of a given property, and price at which we can purchase the asset. We also seek out the right team — including our sponsor partner who co-invests alongside us to execute the business plan. After a diligent evaluation, we may ultimately decide to acquire an asset in one of our targeted asset classes which include multifamily, office, or hotel properties.

Our real estate investment and target market strategy plays a critical role during the acquisition phase. It determines how we identify and execute on attractive opportunities to generate outsized risk-adjusted returns for our investors. We supplement our substantial investment experience with traditional, alternative, and proprietary data sets. These enable us to proactively identify markets and microlocations in which we want to invest, screen more opportunities, and programmatically surface both risks and opportunities during the acquisition phase.

(Read more: Cadre’s Edge: How Data Drives Our Investment Strategy)

Another critical component of the acquisition phase is conventional due diligence, a process that includes investigating and verifying information about an asset. Key components of due diligence may include, for example:

• A building condition audit to identify any deferred capital needs;
• An environmental review;
• Detailed analysis of historical operating costs, leases, and property taxes; and
• Examining proper permits and zoning.

During the acquisition phase, we also construct a business plan to increase the value of the property over time and generate stable cash flow for investors. A typical plan may include steps to assess local market demand, estimate the costs and revenue potential of certain property improvements, and evaluate opportunities for new management to enhance revenues or better manage expenses.

As this is the initial phase of the asset lifecycle, it carries the most “unknowns” for investors and is considered to be a higher-risk/higher-return stage.

Phase two: Value-add

During the value-add phase, we begin to execute the business plan and upgrade the property with the aim of increasing its value and net operating income. These efforts may include significant changes, such as making physical improvements to the asset that will allow it to command higher rents, working to lease vacant space to high-quality tenants, or finding ways to improve how the building is managed and operated through increased revenue and lower operating expenses.

For example, an asset may already have several favorable characteristics, such as a location in a desirable market without much competition—but upgrades such as additional amenities or new kitchens and baths could allow management to raise the rent or increase occupancy. Ultimately, if correctly applied, these improvements should generate attractive returns on the invested capital and improve the property’s cash flow and the value of the asset.

The value-add phase requires experience and innovation to identify an asset’s potential, along with discipline and know-how to effectively execute upgrades that deliver maximum results. In some cases, adding value to an asset may take years to implement successfully —an important reminder of why commercial real estate is best considered as a long-term investment.

Phase three: Stabilization

Once major renovations are complete, we can begin to understand how the upgrades might attract tenants and impact the asset’s value. During stabilization, our focus shifts to more limited capital deployment and how we can maximize property’s cash flow or net operating income.

Upon stabilization, the risk profile of the asset has changed and investors should enjoy more predictable cash flow along with lower risk and slightly reduced return expectations

Throughout the asset lifecycle: Ongoing evaluation and exit opportunities

Throughout the asset lifecycle, we’ll continue to update the asset’s value and projected cash flows, including its NAV, or marked value. Changes to the asset’s value could pose opportunities for existing investors to reap gains by exiting before the end of the established business plan, thereby creating opportunities for new investors to enter an investment in the secondary market as its risk-return profile shifts.

Let’s consider a few examples:

• Existing investors: In some cases, existing investors may look to continue to reap gains once major renovations have been completed and an asset stabilizes. Since tenants may now be paying higher occupancy and rents, some investors may want to continue collecting the associated cash flows. In other cases, investors who participated in the initial offering during the acquisition phase may want to exit prior to the full execution of the business plan, since the building value has already appreciated and the investor can realize an attractive return.
• Potential investors: A new investor may be unsure about an asset’s business plan and prefer to take a “wait and see” approach by investing in a plan that’s already well into its execution phase, instead of a recently acquired asset. After seeing that renovations completed during the value-add phase have successfully started to produce higher rents, a potential investor may choose to invest upon stabilization. A potential investor can access a stabilized asset by making an investment in the secondary market.

Our Secondary Market affords investors the potential opportunity to enter investments at a different stage of the asset’s lifecycle, and with the benefit of seeing how it has performed through at least part of its business plan. Those benefits, aided by a firm understanding of the lifecycle of an investment, can give investors the confidence to enter secondary offerings with greater conviction.

To become an investor and access opportunities on our Secondary Market, please request access to the Cadre platform.

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