Investing in Different Real Estate Sectors
For decades, most real estate investors have been limited to just a few types of real estate sectors. But this is changing. Today, investors can choose from an array of asset classes and sub-sectors within those categories. To help you better understand these sectors and how they differ from one another, we’ve created this guide for understanding what makes each sector unique.
Before we dive into the real estate sectors themselves, we always emphasize the importance of investment strategy. A strong strategy allows investors to make informed decisions about their investments, which is especially critical in real estate because of its long-term nature.
Each sector has its own characteristics, risks, and rewards. While certain real estate sectors may be more appropriate for certain types of investors, there is no one “right” approach to investing in real estate. The key to success is knowing which sector is right for your needs and objectives—and making sure you have all the facts before making an investment decision whether it be a residential, commercial, or land investment.
Residential Real Estate Sector
Residential real estate is the most common form of real estate investing, and it’s what you’re likely to be familiar with if you’ve ever bought a home or apartment before. This sector consists of single-family units, which make up the bulk of American real estate. Also included here are small multifamily properties that have four or fewer units. The residential market is mostly independent of the economic cycle because there’s consistent demand for housing no matter what market conditions are like.
This segment is great for beginners because it’s liquid and affordable. You can sell your investment quickly and it also has low barriers to entry, as any investor can get started with as little money as possible (you don’t need millions of dollars for capital).
One downside of this sector: there are generally no economies of scale; each property has unique challenges to overcome for it to become profitable (e.g., remodeling). It also takes time before most investors see their investments pay off since they have to wait until long after they buy a unit before they start seeing profits—and even then, they could still lose money if they don’t manage their properties carefully (for example by neglecting maintenance issues). Finally, valuation can be more difficult when buying into residential real estate instead of a commercial property already holding tenants, making a comparison of investment opportunities more difficult. Because of these pitfalls, it is incredibly difficult to scale your portfolio without help from others.
Hybrid Real Estate Sectors
Multifamily
If you are looking for an investment class that combines the stability of residential real estate with the potential for gains, multifamily might be just what you are looking for. Multifamily properties are an attractive investment option for real estate investors whether it is apartments, condominiums, or townhouses. They provide the stability of residential real estate, but at a lower cost per unit than single-family homes. Economies of scale and higher efficiency also play into this real estate sector. For example, if you buy ten single-family homes in your local market, each one of those homes is its own business and requires time and resources from yourself as well as property management companies. This means that managing ten different properties takes more time than managing one multifamily building with ten units in it.
Multifamily properties are also inherently less risky than single-family homes because they tend to generate cash flow more easily through rents than single-family homes do through sales transactions (although there are exceptions). While this makes them easier from an investor perspective, it also makes them more attractive from an economic perspective because they have less volatility in their performance over time relative to other types of investments such as stocks or bonds which means they offer better diversification benefits when combined with other asset classes like residential real estate.
Although economies of scale can make management more efficient, managing a single multifamily building is more difficult than a single SFR. Managing multiple tenants can be overwhelming if done incorrectly so make sure before investing in any rental properties that you understand how much time management takes per unit per month so there are no surprises later down the line when taxes come due, or repairs need to be made. For this reason, many time-challenged investors choose to invest with a firm that can manage their day-day physical and financial responsibilities.
Student Housing
Student housing is a variation of multifamily investments, which are growing in popularity as higher education attendance grows. Student housing is a niche market that involves renting out apartments and houses to college students. Students are a captive audience since they cannot easily move away from campus, making higher rents more attainable. The stability and growth of this market have made student housing incredibly attractive for investors, who can expect steady returns on their investments over time.
Commercial Real Estate Sectors
After buying in commercial real estate sectors, property owners rent out commercial properties to businesses. Commercial properties can be any type of building, including office buildings, retail stores, warehouses, and more. Commercial properties tend to be larger in size than residential properties and therefore have higher price tags—but with that comes the potential for higher returns on investment if investors are willing to put in the work. The downside is that commercial real estate can be riskier because it involves more management skills, and investment success correlates with your tenants’ success.
Office
A building’s location and the type of business conducted there define your success in the office sector. Office buildings can be single or multi-tenant, as well as managed internally or by a third party. Management can be difficult because of changing tastes, competition from other locations, and technological improvements—all of which contribute to today’s changes in office real estate.
There has been a decline in demand for office space due to advancements in technology that allow employees to work remotely more easily than they could before. This has resulted in decreased occupancy rates across cities, leading developers to convert vacant spaces into apartments or other uses with higher demand potential based on current trends.
Industrial
Industrial properties are used for manufacturing, warehousing, and distribution. They have unique characteristics that make them attractive to investors. For example, industrial property contracts have leases for the long-term with stable cash flows; these contracts can last anywhere from 5 years to 20 years or more. The industrial real estate market is booming in the US due to increased demand from e-commerce companies like Amazon and Walmart. The growth of cloud computing will also contribute to this sector’s growth, with a tremendous future need for data centers and server storage.
There are several other factors driving growth in this segment:
- Increasing labor costs in China has resulted in many manufacturers moving their factories back home (to Mexico and the US).
- A slowdown in construction during 2008–2009 created an oversupply of industrial space while supply remained tight during 2010–2013 (this caused vacancy rates to rise).
- Construction activity has picked up significantly since then leading us into a shortage of warehouse space across many parts of the country now going on 10 years!
The downside of the industrial real estate segment is the high barrier of entry. It will be near impossible for an individual to own an industrial asset without going through an investment fund or a REIT.
Retail
If you are interested in investing locally, retail properties are an excellent option. Retail properties can be anchored by one large tenant, such as a grocery store, and therefore easier to manage as opposed to office or industrial buildings, which tend to be more flexible with their leases.
Often, these leases are triple net lease agreements. This means that the tenant pays for all property taxes, insurance, and maintenance costs associated with the space. This differs from gross leases in which both parties are responsible for these expenses. Retail leases are usually long-term, which means you can miss rent increases each year. However, this does add stability and minimize risk as tenants will have to buy out their lease to leave early.
As with any investment type, it is important to have realistic expectations when investing in retail properties because changes in consumer trends and economic cycles affect them more so than other asset classes. If you are thinking about getting involved in this real estate sector, make sure you do your research on current market conditions before making any decisions or you can collaborate with a firm to invest for you!
Healthcare
No industry employs more workers than the healthcare industry. Yet the healthcare real estate sector is still a growing market. Types of healthcare properties include hospitals, clinics, and medical offices. This real estate sector can provide great returns and stability, but less affordable prices sometimes limit exposure.
Investing in healthcare REITs is one way to get involved in this type of property without paying full price for it yourself. These REITs have lower volatility than other REITs because they’re tied to healthcare services rather than residential or commercial property markets which can be more volatile depending on economic conditions.
Self-Storage
The self-storage market is growing rapidly. It is a sound investment for people who want to invest in real estate but don’t want to manage it. Because self-storage facilities are recession-proof, they can have great stability for an investor. However, if the economy declines significantly people may get rid of their discretionary property altogether. Market research and demographics are extremely important when choosing a location for storage facilities.
You can manage your own self-storage business, or you can buy pre-existing ones; either way, it’s a great way to build wealth over time while enjoying passive income every month if you can overcome the numerous competitors.
Hospitality
Hospitality is one of the most diverse asset classes, with a wide range of properties from luxury hotels to budget motels. It is not only a business-to-business investment; it also includes Airbnb rentals and other short-term space rentals, which are popular with tourists. It is an industry with high revenues and high expenses and one of the most loved assets of the American elites.
Because hospitality properties are often located in popular vacation destinations, they have high turnover rates. Managing these properties can be difficult because of the need to rent out rooms and maintain customer satisfaction during peak seasons (summer) or at times when there are no guests (winter). Additionally, intense competition from large players such as Hyatt and Marriot can make a smaller property suffer. It would be more prudent for smaller investors to invest with a company that already has a history of successful hospitality management or a property manager that can run your Airbnb portfolio.
Agriculture
When you think of agriculture, you may picture lush fields and green pastures. However, the term “agriculture” is a broad one. It covers everything from farms to ranches to timberland to wineries and other food-related businesses. Because of this wide range of properties, including some that are not as easy for investors to access (such as small farms), it can be difficult for real estate investors looking for an asset class with solid returns on investment (ROI).
Investing in agricultural real estate offers investors an opportunity to diversify their investments globally by investing in farming operations located anywhere in the world. Agriculture tends to be less volatile than other segments of real estate investment because demand for crops does not fluctuate as wildly with changing economic conditions as residential or commercial properties do; however, some agricultural investments will always be more susceptible than others due to their sensitivity to changes in global weather patterns or international trade agreements (for example farmers who produce commodities like wheat are especially at risk if there is a drought).
In general, the potential for returns within the agriculture real estate sector is low because of the perceived low risk, but a great investment strategy can always overcome poor external conditions and create better returns.
Land
The land is a very long-term investment as it is one of the least liquid of all real estate segments and does not provide cash flow. Investors can sell, lease, or develop, and even subdivide into smaller parcels like residential or commercial properties. Contrary to the income-based valuations of commercial property, land value is determined by income potential. Property zoning, access to infrastructure, and location help determine value; land that is near a transit station has a higher value than land that is far away from public transportation.
Land can be purchased with the intent of developing it at some point in the future—which often happens when land values are low—or to hold onto rent-free until you are ready to sell later on down the road (if such an opportunity arises). Purchasing undeveloped lots as an investment vehicle can bring you huge returns, however, you should do extensive research before jumping into any new venture to minimize risk!
Jumping into a Real Estate Sector
All the benefits of real estate investing may tempt you to jump in with both feet, but it is important to have a firm understanding of the risks and benefits of each type of real estate sector. Different real estate sectors have their own needs and demands, which means that one may be better suited for your portfolio than another. You should also consider your skill set and the time you need to spend managing your properties—some types of real estate require more work than others do. The best thing you can do is start by learning about the different options available today so that you can make an informed decision about which one fits best within your financial goals (or lack thereof).
Real estate investing should be wholly customized to the personal and economic circumstances that will impact your investment. For investing help, you can always reach out to us at invest@eikoninvestments.com.
Happy Growth.
