Real estate investing encompasses a wide variety of property types and each one comes with a unique set of pros and cons that depends on the type of property invested in.
In this article, we are going to describe six types of real estate investing and the pros and cons of each. By the end, readers will have the information necessary to determine which type of property investment is a best fit for their own risk tolerance, time horizon, and return requirements.
At First National Realty Partners, we are a private equity firm who specializes in the purchase and management of grocery store anchored retail centers. If you are an accredited investor, interested in partnering with a private equity firm to allocate capital to a commercial real estate investment, click here.
Type #1: Commercial Real Estate
Commercial real estate is property that is leased to, or run as, a business. For example, a multifamily apartment building with more than four units is considered to be a commercial property.
There are a number of benefits to investing in a commercial property that include rental income, favorable tax treatment, and the opportunity for price appreciation when market conditions are right.
The major downside to a commercial investment property is that they are typically very expensive and likely out of reach for all but the most well funded investors. In addition, they can be more complex (and expensive) to manage. Fortunately there are suitable workarounds for both of these issues.
For individual real estate investors looking for exposure to commercial property, there are several types worth considering.
Private Equity Real Estate
As the name suggests, a private equity firm is one that invests in the privately held equity of other companies, including those that own commercial real estate. In a typical private equity structure, an investor places their money with a firm, who does all of the hard work to find and manage a property while the investor collects passive cash flow. The major benefit of this approach is that it allows individuals to gain fractional ownership of a property, which is the workaround for the cost issue described above.
The downside of this approach is that the minimum required investment can be large, the required holding can be long, and the fees charged by the private equity firm can cut into profits.
Another popular commercial option is to purchase an office building and lease space in it to business tenants. Office buildings can range from the kind of generic space used by banks or accounting firms to the highly specialized space used by doctors offices and hospitals.
Investors like office buildings because they typically come with long term leases (3-5 year minimum) and a business tenant is typically less likely to default on their lease payments than an individual.
But, office buildings can also come with a set of challenges like limited parking in major business districts and the security challenges that can come with a large, visible property.
Lodging & Hospitality
Lodging and hospitality properties can range from a small bed and breakfast to a major chain hotel or restaurant.
Investors like these properties because they are often highly visible, have great locations, and can produce significantly more income per square foot than an office or retail property when they are fully occupied.
But, hospitality and lodging properties have a unique set of challenges. Their income can be highly variable (especially in seasonal locations or economic downturns) and the high end finishes required to wow guests can be incredibly expensive.
Retail properties encompass a wide variety of options from single tenant stores to shopping malls with a hundred tenants. The size, location, finish, and tenant(s) have a significant impact on the value of the property.
Investors like retail properties for their highly visible locations, long term leases, and generally strong lease rates.
However, retail is also a business that has notoriously struggled in the age of online shopping and there is a potential to see higher rates of default among commodities retailers whose products can be easily sold and shipped online, like clothing or office supplies.
Grocery Anchored Retail Centers
Despite the challenges for general retail concepts, there is a sector of the retail business that we steadfastly believe in and we call it essential retail. It includes tenants who sell essential goods and services that have been resistant to ecommerce driven disruptions that have been such a challenge for other areas of the retail space. Essential retailers sell goods and services that are essential to everyday life, think grocery stores, quick service restaurants, boutique fitness studios, hair salons, and of course grocery stores.
We like the grocery-anchored retail space because these are difficult shopping experiences to create on the internet – you can’t get a haircut online – and they are discretionary purchases, so they are less impacted by changes in macroeconomic conditions. For example, every individual alive needs to eat food, every day to survive, regardless of economic conditions. For this reason alone, we have organized our entire business around grocery store anchor tenants.
The downside to essential retail is that this is a competitive space and it can take a significant amount of leg work to find the right deals that have the best chance for a positive return. However, investing through a private equity firm cuts out an individual investor’s own work.
Type #2: Residential Real Estate
By definition, residential real estate is any type of property that: (1) is a place where people live; and (2) has four residential units or fewer – anything more than four units is considered to be a commercial space.
For many investors, a residential real estate investment is more accessible because it is typically less expensive to purchase and less complicated to manage. The most common uses for a residential property are either a long term rental lease of a year or a short-term vacation rental (like Airbnb). For investors, there are generally two types of residential properties to consider.
As described above, residential apartments have four units or less. So, an investor could purchase a condo, duplex, triplex, or quadplex and lease the space to tenants while outsourcing property management activities to a third party or managing them on their own.
Investors like apartments because everyone needs a place to live so they often have good occupancy rates and rate changes are far less cyclical than other sectors.
The downside of an apartment investment is that they can be time consuming to manage – think landscaping, painting, and fixing broken toilets. In addition, because of their relative safety, they tend to have lower returns than other property types.
A single family home is one that is detached from the other structures that surround it and it is often purchased as a rental or fix and flip.
Investors like single family homes because they are far less expensive than a commercial property and debt is generally widely available at favorable terms.
But, they also require a lot of upkeep and owners must exercise a lot of due diligence when selecting tenants because it is possible that they could neglect or damage the property, causing expensive repairs, which can wipe out years of profits.
Type #3: Industrial
Industrial properties are an asset class that encompass a wide variety of uses from light manufacturing to storage and logistics. Industrial properties have become particularly important in recent years with the continued rise of ecommerce and the delivery demands that it requires.
Investors like industrial properties because they don’t require expensive build outs and their maintenance cost on a per square foot basis is less than other types of investment. In addition, they are becoming increasingly important as distribution centers to complete last mile delivery to the homes of online shoppers.
The downside to industrial properties is that they have large physical footprints, can be very expensive, and can require specialized knowledge to manage.
Type #4: Raw Land
In terms of risk, raw land may be the highest risk/highest return option than an individual can add to their investment portfolio. Raw land is property that has no entitlements, no utilities, and no electricity. It can be purchased in a rural location or as a vacant infill lot in a more urban location. Typically, it is purchased with the intent to build something on it – like a retail center, apartment building, or office building.
As an investment option, individuals and developers like land because it can come with the potential for high returns and it provides a chance to put forth their vision of what a property could be.
However, raw land also carries significant risk in the sense that it can take a very long time to receive all of the approvals and permits necessary to begin construction and there is no guarantee that they will be issued. In addition, the time from land purchase to completed project can be several years and market conditions can change significantly during that time, which can have an impact on project returns.
Type #5: Special Use Properties
As the name suggests, special use properties are those that have a special use, like senior living facilities or medical office space. They are known as “special use” because these property types require some type of specialized buildout or equipment for the intended purpose. For example, a medical office may need to have a sturdier build to accommodate extremely heavy equipment like MRI machines.
Investors like special purpose properties because they typically have strong demand and relatively limited supply, which means that they stay occupied with strong rental rates.
But, special purpose properties are also more expensive to build and can be especially difficult to adapt for a new use if they become vacant. For example, it would be very difficult to repurpose a movie theater into a retail store.
Type #6: Real Estate Investment Trusts
A Real Estate Investment Trust – REIT for short – is a specialized type of real estate company that owns, operates, or finances real estate assets. If these companies follow a series of IRS rules, they are able to avoid the double taxation of a typical corporation. Generally, there are two types of REITs, public and private.
Publicly Traded REITs
Publicly traded REITs are those whose shares can be bought and sold on public exchanges and they often specialize in certain property types. For example, Prologis is a large REIT that owns and manages warehouses and logistics space while Simon Property Group owns and manages shopping malls nationwide.
Investors like publicly traded REITs because they provide passive income, portfolio diversification, and liquidity. In addition, they typically have low minimum investment requirements.
The downside of a publicly traded REIT is that shares prices can be occasionally volatile in a way that does not have any connection to the conditions of real estate markets, interest rates, or property values. In addition, investors do not have a say in the decisions about which properties to purchase or how to manage them, these are left up to the REIT.
Privately Held REITs
Shares in a privately held REIT are not publicly traded. They are bought and sold directly from the REIT or through a private broker-dealer network.
Investors like shares in a privately held REIT because firms may have more leeway in the types of properties they purchase and the way they operate them. In addition, the private REIT may have access to come deals that their publicly traded counterparts do not. Finally, a privately held REIT is not subject to the cost of complying with strict compliance rules that publicly traded firms contend with.
The downside of a privately held REIT is that they can be illiquid and may have high upfront management fees that can cut into returns.
The Importance of Understanding the Types of Real Estate Investments
Every individual investor has their own risk tolerance, return requirements, time horizon, and amount of investable capital. In addition they may have their own unique preferences for certain property types or asset classes (like the stock market, mutual funds, or crowdfunding platforms).
For this reason, it is important for investors to understand the different types of available real estate investing opportunities because they can evaluate each of them to determine which is the best for their own individual preferences. Real estate investing is not about finding the “best” investment, it is about finding the most suitable for each investor.
Summary of the Types of Real Estate Investing
From purchasing a property directly to real estate crowdfunding, there are many different ways for an individual to invest in real estate properties.
It is important for investors to understand their options to determine which real estate investing strategy is the most suitable for their own individual preferences.
Interested In Learning More?
First National Realty Partners is one of the country’s leading private equity commercial real estate investment firms. With an intentional focus on finding world-class, multi-tenanted assets well below intrinsic value, we seek to create superior long-term, risk-adjusted returns for our investors while creating strong economic assets for the communities we invest in.
If you would like to learn more about our commercial real estate investment opportunities, contact us at (800) 605-4966 or email@example.com for more information.