Commercial real estate life cycle.

At a Glance —

• There are four main stages for most commercial real estate (CRE) investments — acquisition, stabilization, value-add and sale
• Important activities occur in each phase of the CRE life cycle in order to optimize value and support the longer term exit strategy
• Understanding the life cycle and relevant activities can help investors to adopt an informed investment strategy

Commercial real estate (CRE) can be a highly profitable investment when managed and executed well. This involves planning, purchasing and managing income-generating properties — retail centers, office buildings, industrial facilities, multifamily housing, hospitality and other special purpose properties — with the aim of generating income and achieving capital appreciation.

Here, we’ll summarize the life cycle of commercial real estate investments. Those phases generally include —

Acquisition

The first step in commercial real estate investing is the acquisition of a property. Prior to acquisition, the pre-planning activities involve identifying potential properties that meet specific investment criteria. Things like location, type, and size. Then, due diligence begins which is vital to confirm the property’s financials and physical condition and potentially align with the operator’s objectives.

Once a suitable property is identified and vetted, the operator will negotiate the purchase price and terms, secure financing, and close the transaction. The operator’s goal at this stage is to acquire the property at a price which allows for future growth and profitability.

Stabilization

After acquiring a property, the operator’s next goal is to stabilize the property by attracting tenants and generating positive cash flow. The stabilization stage typically involves improving the property’s physical condition. Things like repairing or upgrading the building’s infrastructure, common areas and tenant spaces. Marketing efforts are crucial in attracting tenants and maintaining occupancy rates.

At this stage, the operator’s primary focus is on generating positive cash flow and covering all operating expenses, such as property taxes, insurance, and maintenance costs. Operators typically hold onto the property during this stage until they achieve a certain level of cash flow and stability.

Value-Add

Once a property is stabilized, the operator may consider implementing value-add strategies to increase the property’s value and potential for future profitability. This may involve upgrading or renovating the property, improving tenant amenities or repositioning the property in the market.

Value-add strategies aim to increase rental income, occupancy rates and property value, which can lead to higher returns when the property is eventually sold. Value-add strategies require careful planning and execution as they may involve significant capital investment and may require lengthy tenant lease negotiations.

Sale

The final stage of commercial real estate investing is the sale of the property. The operator’s goal at this stage is to maximize the property’s value by selling it at a premium price. The timing of the sale is critical, as the operator will want to sell the property at a time when the market is favorable and after the property’s value has appreciated.

Successful commercial real estate investing requires a long-term vision, sound financial strategy and a willingness to adapt to changing market conditions. Investors in commercial real estate must be positioned to commit funds to the investment for an extended period, often multiple years. Additionally, CRE investors must have a longer-term investment strategy to be prepared to weather market fluctuations and changes in the local real estate market.

Bottom Line —

For CRE investors, it is important to understand the life cycle, the potential risks and benefits, and to have a long-term investment strategy that takes into account the illiquidity of the investment. Each stage of the CRE life cycle requires careful planning and execution to achieve the operator objectives to generate income, increase property value, and maximize investor returns.