Value-add real estate, which are properties exhibiting marginal operational or physical challenges, offer better total return prospects than core real estate, according to a white paper from CenterSquare Investment Management, a real estate specialist for BNY Mellon.

The paper, Era of Execution, written by P.J. Yeatman, head of private real estate for CenterSquare, and Jeffrey Reder, senior vice president, private real estate, for CenterSquare, focuses on the potential of value-add strategies to generate attractive risk-adjusted returns in private real estate.

Value-add strategies involve acquiring real estate at an attractive cost basis and then resolving the property’s deficiency, stabilizing the income stream, and increasing the overall value of the property for disposition.

Core real estate, generally defined as high-quality assets in prime locations with stable cash flows, is traditionally viewed to have the least risk. These properties were the first to attract significant institutional capital from risk-averse investors following the Global Financial Crisis. As a result, this segment of the private real estate market was the first to recover, according to the report.

But now these core properties appear to be over-valued, and better investment opportunities can be found within value-add real estate, CenterSquare said.

Yeatman said: "Our view is that we have entered an era in which value creation through strategic execution offers the most compelling risk-adjusted returns. The raw materials for a value-add real estate strategy can still be acquired at an attractive cost, particularly when compared to core properties, which appear to be overbought."

Reder said: "We see assets that are not functioning optimally, but can be improved so that their value and ability to deliver returns to investors are both significantly increased."

CenterSquare also noted that in past market cycles, recovery of private market values have lagged that of public real estate market values.

Yeatman added: "Based on the public market value recovery we’ve seen since 2009, we can infer that we are in the midst of an optimal private market investment period."

Another advantage of value-add strategies singled out by the report is that because of the low cost basis at which they can be acquired, they are better positioned to withstand potential shocks to the market. In the white paper, Center Square said the most attractive value-add properties are primary assets in secondary growth markets and secondary assets in primary growth markets.