No matter if you are an experienced investor or just getting started in commercial real estate, you might be wondering whether it’s better to invest in a stabilized asset or a development project.
A stabilized asset may seem like the more appealing option due to its lower risk. However, stabilized assets don’t provide the same yield growth opportunity as development projects. Additionally, working with a qualified real estate and investment development company can boost your chances of success when investing in any type of development project.
In this blog post, we will take a closer look at how stabilized assets and development projects compare. And then we will share some ways to set yourself up for investment success.
A commercial property is a stabilized asset once it reaches 85% occupancy or nine months after construction completion, whichever comes first. Meanwhile, a ground-up building project or value-add renovation project would fall under the category of a development project.
If you are in the market to buy an apartment building as an investor and decide to take out a mortgage and invest in a stabilized asset you are unlikely to make a significant profit. You might make a little extra money each month on the property, but it is a lower reward scenario.
Typically, if you buy an apartment building with tenants already occupying the property and then rent it out — if you are lucky — you will get somewhere between a 3% to 5% return every year. If you buy a house and rent it out you might get a slightly higher return, but it is still minimal.
In Southern California, where Beach City Capital operates, we have a lot of real estate syndication companies that pool investor funds to finance commercial properties. A lot of times they will put your money in a stabilized asset. For instance if you partner with a bigger company that buys apartments you can expect to see a 5% to 8% return, give or take. Your overall return over a 10 year period would be around 2x. There’s low risk, but there’s also low reward.
A development project is often referred to as a high-risk, high-reward commercial real estate investment. If you partner with an experienced development company and invest in a property early, you can expect somewhere around an 8% or higher yield. On a five-year hold you could expect to earn 2.5x on your money, but on a 10-year hold you could earn 3.5x on your money.
Your annualized return in that scenario where you invest in a development project is somewhere around 20%. When you compare that to a stabilized asset, where there is lower risk, you might end up with a 3% annualized return on your investment. That’s a lot less money over time.
Investing in development projects is the clear winner for building your yield.
Investing early in a commercial real estate project is a great way to build your yield, but it also comes with increased risk. You can mitigate risk by partnering with a qualified development company. Location also plays a huge role in the success of any development project.
Development is risky, but so is surgery. You wouldn’t hire a recent medical school graduate to do your surgery, you hire a licensed surgeon with training and experience. On a similar note, you wouldn’t hire an inexperienced builder to develop a large property. You want to partner with a qualified commercial builder that can handle design, construction management and asset management. You also want someone who knows and understands capital markets.
Always make sure to do some research on those involved in a commercial real estate project before investing your funds into any ground-up or value-add development. Choosing the right sponsor is an important component when investing in any development. Invest wisely and you can expect to see long-term results that will ultimately help you increase your overall yield.
Building your yield does not only involve choosing the right partner, you also need to select the right location. You want to invest in an area that is going to be in demand in perpetuity.
Successful commercial real estate investment is all about making sure your asset is in the right place where it is going to appreciate in value. You must think strategically about its proximity to public amenities, such as the park, the beach, grocery stores and retail, work hubs and more.
La Jolla and Manhattan Beach are two now iconic California communities where the real estate market picked up and stayed very active. Investors that got a foothold in development projects within those communities early built massive wealth for themselves and their families. Boca Raton in Florida is another example of a community that has made investors a lot of money.
An investment in the right community will put you one step closer to building your yield.
The “secret” to building your yield is taking a little more risk. When you take the time to find the best sponsor — one who understands the development process from start-to-finish — and the best location to develop, this will result in you getting a higher return on your investment.
At Beach City Capital, we strive to have the best property on the block and in the neighborhood, and all of that happens through our thoughtful design and pre-development process. We take on development projects that demand the highest rents, while also improving the local community.