CRE project opportunities, whether you want to get your EB-5 Visa or simply add to your overall investment plan, is like playing chess.  Some “moves” (read: securities or real estate sectors) are riskier than others.  Carofin wants you to be informed in advance before investing.

Assessing Risk/Return

High-net-worth investors can select several security structures, each tailored to specific investment objectives and varying levels of risk. Some more conservative, offering modest returns, to ventures offering potentially higher rewards but with increased risk.

For individuals seeking to obtain a permanent visa through the U.S. EB-5 program, investing in real estate projects typically meets the program’s job creation requirements.

Security Structure / Capital Stack

When commercial real estate (CRE) sponsors raise capital for projects, they approach various sources, from institutions to high-net-worth investors, to finance different layers of what’s called the “capital stack.”  At the top, we have senior debt – the cornerstone for those seeking steady income.  This form of financing, like a first-position mortgage, is commonly used for property acquisitions or refinancing.  It is secured against the property, providing investors with priority in case of liquidation and carrying the least risk within the capital stack framework.¹  Generally, sponsors will fill senior and mezzanine debt with financing from institutions.

Moving down the stack, mezzanine financing typically offers higher interest rates and current income.  However, being subordinated, it offers a higher risk profile.  Mezzanine loans commonly yield mid- to upper-teens rates, but investors typically don’t participate in dividends or capital appreciation, receiving a lump sum (balloon) payment at maturity instead.

Finally, we reach preferred and common equity, functioning just as they do in other industries.  These investments represent ownership stakes in the funded entity, with common equity generally bearing the highest risk and potential return.  Preferred equity ensures investors’ rights are met before common equity holders in liquidation, often featuring a preferred return, receiving profits or distributions before common equity holders.

Understanding where a security lies within the capital stack is crucial for aligning it with your investment profile.  It’s like knowing which chess piece to select and its inherent risks and returns.

Investment Classifications

After learning what type of security most fits your situation, turn your attention to each commercial real estate classification.  Just as the structure of a building tells you about its stability, understanding the investment classifications in CRE gives you additional insights into the risks and rewards involved.

Core: The Low Risk / High Quality Opportunities

Core investments are like the sturdy foundation of a building – low-risk, with stable income streams.  These properties are usually top-notch, situated in prime locations in major, or primary, markets, and are leased to reliable, creditworthy tenants for long periods.  Think of a bustling shopping center like Fashion Island in Newport Beach, CA, anchored by big-name stores such as Nordstrom.  If you’re all about steady cash flow, this is your go-to category.

Core+: One Notch Riskier / Relatively High-Quality Opportunities 

Core+ investments share similarities with core properties, offering stable cash flows. But they also have the potential for modest value enhancement.  In exchange for minor improvements or strategies to address higher vacancy rates, for instance, sponsors may be able to increase their value.  Accredited investors and family offices often find these appealing, although they carry a tad more risk than core properties.

Value-Add: Improvements = More Risk / Income and Capital Appreciation

Value-add investments are like renovating an old shopping mall – riskier but with the potential for higher returns.  Here’s the deal: you acquire properties with untapped potential and boost their value through thoughtful upgrades, lease-up and renovations, or operational enhancements.  While they offer the chance for bigger profits, they’re more speculative than core projects.  It’s like playing in the big leagues – recommended only for seasoned investors who know the game well.  Investors should trust the expertise of experienced sponsors before diving in.

Distressed: Significant Risk / Potentially High Returns

Now, let’s talk about distressed properties – high risk, high reward.  These are like fixing up a run-down housing development and selling it for a hefty profit.  The sponsor acquires properties facing financial trouble, foreclosure, or operational issues at below-market prices, aiming to turn them around for a tidy sum.  These investments are not for first-timers. You’re betting on the potential of big gains, but they come with uncertain cash flows.  Only experienced investors with a high tolerance for risk should venture here, and, even then, it’s wise to work with seasoned sponsors who know the ropes.

Opportunistic: High-Risk, High-Reward Opportunities

Opportunistic investments are like embarking on an ambitious construction project – the highest risk, but they pose the highest reward.  These ventures involve significant development, redevelopment, or ground-up construction projects, often in emerging or niche markets, like buying a vacant office building, demolishing it, and developing a lifestyle center.  Cash flows invariably are negative during development phases, but they offer the potential for substantial returns.  This is the playground for seasoned investors seeking maximum profits, but it’s not for the faint-hearted.  If you’re moving forward in this direction, make sure you’re partnering with sponsors who have a proven track record in these high-stakes endeavors.

Measuring risk in commercial properties is critical, no matter your motivation.  If you are domiciled in the U.S. and are seeking to prioritize your EB-5 visa, investing in a project that will generate the required number of jobs until your application has been accepted is essential. Selecting a well-regarded sponsor who is offering a Core or Core+ opportunity might be a more appropriate approach to take.

Alternatively, if you are a seasoned investor with a well-diversified portfolio and can accept higher risks with a longer-term horizon, value-add, distressed, or even opportunistic projects might fit your appetite.  Be sure to survey the board before you move your first pawn! For more information, please see carofin.com.

¹ The actual amount and timing of distributions paid is not guaranteed and may vary. There is no guarantee that investors will receive distributions or a return of capital. These programs can give no assurance that they will be able to pay or maintain distributions, or that distributions will increase over time.