What’s the optimal way to invest in real estate? Conventional wisdom says value-add and opportunistic strategies provide higher returns vs. core, but come with higher volatility. There’s debate about this, with some studies showing core outperforming net of fees over the long run, and the question has never been cleanly settled.

It has historically been a hard question to answer because returns have been measured at the fund level, not at the asset level. But a new working paper for the first time examines asset level performance for each category over the last 20 years and finds… that we’re not asking the right question, especially related to the non-core strategies.¹

Non-core real estate strategies come in several different varieties and each has a different return profile, which we’ll get to below. But there’s an overarching factor that cuts across all of them: The non-core data shows a “strong correlation” between high returns and growth markets. Where you pick a value-add asset drives more of the outcome than what you pick.

In this study, the authors defined core assets as having less than 50% leverage and being more than 80% leased. These assets historically have seen a higher share of their total return come from income during the hold period vs. appreciation.

In contrast, value-add and opportunistic investments share an expectation that most return will come from appreciation. These are lease-ups, repositionings, redevelopments and ground-up developments, each of which require specific sponsor skill sets, higher-cost financing and greater dependence on the capital markets at the time of exit to achieve the hoped-for returns.

One of the study’s key observations: core assets do “very well” in declining interest rate environments. From 1999 to 2023 there were three cycles of decreasing and then increasing rates, and as rates dropped core funds exceeded not just their own returns targets but at times exceeded those of the value-add and opportunistic funds (i.e. 15-18%). They struggled during expansion markets however.

If today's rate environment marks the beginning of another contraction, history suggests core assets could again benefit from falling rates and cap-rate compression, at least for a time.

Another key finding: Development is the best non-core strategy overall and was especially high-performing in the 2013-2022 period. Ground-up averaged 11.2% annual returns during that time compared with 8.3% for stabilized assets.

You’d think the sudden increase in rates that started in 2022 might have flipped the script, but development strategies still outperformed, although real estate values fell overall. On a risk-adjusted basis, development performed very well in contraction markets (periods of falling interest rates) and performed well in expansion markets too, illustrated by the graph and table below.

The critical caveat is that development strategies, while great on average, mask a diverse scatterplot of returns based on geography. And the location premiums don’t sit still: During the mid 2010s developments in core markets like NYC and LA strongly outperformed, and from 2016-2022 that shifted to Sunbelt and secondary markets like Nashville and Austin, the study says.

Outside of development, returns for lease-up strategies were more volatile and dependent on market conditions. That’s likely because they focus on the marginal available spaces - under-leased assets bought at a discount and re-introduced to tenants aren’t usually core quality and are designed to be first in line to catch expected new growth in a submarket. Despite being somewhat more volatile than development, they held up relatively well, including in the worst recent down year. Case-in-point: “In 2023, leasing strategies’ return was at -7.0%, compared to -8.2% for core/stabilized and -4.7% for development.”

Finally, sponsors who pursue rehabilitation and repositioning strategies have historically focused on either apartment or office assets, and you can imagine how that’s gone. Apartment rehabs did relatively well, office buildings not so much, and the striking delta is reflected in the graph and table below.

In all, the various strategies each had moments in the sun between 2004 and 2023 - there were years where each one achieved the best returns. But the pattern isn’t surprising: Soon after the GFC, core assets outperformed, then leasing strategies, then development. “This period marked the transition from a market characterized by value recovery to one driven by value creation.”

The central lesson from this research is that conventional wisdom has oversimplified the relationship between risk and return in real estate. “Non-core” is usually discussed as a few broad categories—core-plus, value-add and opportunistic—but those labels explain very little. Development, lease-up and rehabilitation strategies produced materially different outcomes despite often being grouped together, and the highest risk-adjusted returns frequently accrued to investors positioned in what are conventionally considered the riskier investments. The study’s strongest evidence points to a re-evaluation of what risk/return profile to attribute to each of these strategies, one that could make us all better at what we do.

Ask whether asteroid mining is profitable and you run into a paradox. On paper the prize is absurd: one asteroid, 16 Psyche, reportedly holds something like $700 quintillion in metals, and one database pegs just the ten most accessible rocks at $1.5 trillion in profit.

But the moment you actually tow any of it home, you've flooded the market and the price falls through the floor. One Tel Aviv University simulation found a single shipment of space ore would halve the price of gold.

And that's the optimistic problem. The pessimistic one is that NASA's OSIRIS-REx spent seven years and about $1 billion to bring home roughly one kilogram of asteroid, and the two startups that tried to commercialize the idea both ran out of money before mining a thing.

The total addressable market is the size of the solar system; the unit economics, so far, are a billion dollars a kilo, and the payoff destroys itself on contact…

Link: https://hir.harvard.edu/economics-of-the-stars/

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