Types of Real Estate: Explained

Investing in real estate has certain advantages over investing in the stock market, one being that the assets are tangible, and that risks in real estate investment can generally be mitigated or managed more effectively. Investors can choose lower risk property investments with stable income streams. Or, if so desired, decide to invest in situations where overall  returns may be a combination of an income stream plus capital appreciation.

So, let's have a look at a selection of typical real estate asset classes, and weigh up the levels of some of the investment or business risks associated with each primary type of asset:

Offices

Can include large, multi-tenant city center blocks, smaller single-tenant buildings, office parks or converted retail space. Typically, leases may be 2-3 years although, for major space occupiers, are likely to be 5 – 10 years or longer and include annual or bi-annual rent escalations. Lengthy leases and strong tenant covenants ensure predictable cash flow.

Risks: office occupancy and rentals are dependent upon the economy and the ability of the tenant to successfully run its business. But there are also Black Swan events such as the recent pandemic which was a powerful disruption to traditional office occupancy.

New forms of remote working such as hybrid working, and the rise of co-working formats also poses a threat.

Offices are one of the most capital-intensive property types given the high turnover and costs especially for non-CBD properties, the need to keep upgrading as technology and specifications change plus, generally, the cost to re-tenant space is very high.

Multifamily homes

Amongst all major real estate types, multi-family property has typically provided the best risk-return prospects between 1990 to date.

In short, people always need somewhere to live, no matter what the state of the economy and, so, demand is more resilient. Apartments are also the best inflation hedge relative to other major property types due to the lower effect that capital expenditure has on overall appreciation.

Trends of population (ageing) and employment growth and mobility, declining numbers of home ownership, and delayed average age of marriage and/or parenthood all support multi-family demand.

Rents can easily be adjusted upwards in times of inflation or rapid rent growth, as leases are generally of a short-term nature. Acquisition funding is readily available with a variety of Government-Sponsored Enterprises (“GSE”) providing mortgages and loans.

Risks: rising material costs and labor shortages have led to an upward trend in the price of new construction, meaning prices of the finished product will, invariably, be higher.

The downside of short-term leases is that rents can also be adjusted downwards in the event of oversupply or an economic downturn.

Multi-family properties may also be more management-intensive than other properties since they involve dealing with tenants, third-party service providers and management staff on a daily basis.

Retail

Includes major shopping (regional) centers, location-centric malls, small neighborhood strip retail, grocery or food-anchored shopping centers, lifestyle centers, and single-tenant net lease restaurants and buildings.

The underlying fundamentals of retail leasing terms are similar to those of offices, also usually offering longer term leases around 5 – 10 years with regular rent escalations.

The rise in e-commerce or online shopping is dramatically changing the profile of tenants in shopping centers with more of an emphasis on F&B or activities which require a physical presence, such as a gym or shoe store. However, some other retailers are adding brick-and-mortar stores to their business model in order to provide services, better showcase their inventory, and establish their brand in prime locations.

Retail has also seen an influx of service-oriented and experiential tenants enter the space in place of the older style department stores and some operators have found alternative uses for space. These include medical tenants occupying vacant retail in the form of “Medtail” (medical service related centers) or outpatient urgent care centers.

Risks: e-commerce will continue to grow and is the greatest risk to traditional retail real estate. Properties in less attractive locations or with exposure to retailers of less-need-based products and/or less desirable brands currently face significant risk.

Furthermore, tenant turnover costs and capital expenditure costs for upgrading or renovations can be high and affect a property’s capital appreciation. Also, if an anchor tenant vacates, this can cause a domino-effect on the performance of other tenants.

Industrial

Includes data centers, warehouses, factories/manufacturing, distribution, research and

development (“R&D”) centers, and flex or hybrid space.

Some industrial properties are leased to a single tenant, whilst others are multi-tenanted. The rise in e-commerce has had a dramatic, positive effect on the demand for logistics space (warehouse and distribution space), specifically “last-mile” distribution centers.

Occupiers, typically, enter into long-term leases with pre-determined rent escalations and are responsible for most, if not all, operating expenses.

Risks: vacant spaces, especially for the more specific use type properties, can remain so for lengthy periods of time and re-leasing can be costly.

As industrial properties are “working properties”, capital expenditure for repairs and renovations can also be high.

A number of tenants in the manufacturing/R&D space require specialized and expensive buildouts to accommodate specific machinery and technology and such costly improvements cannot always be reused or recycled if the tenant vacates. With strong industrial fundamentals over the last few years, a significant number of investors have been attracted to the sector, thereby reducing cap rates and investment returns.

Hospitality

Includes hotels (owners and operated by major branded chains or boutique properties), motels, extended stay accommodation, coastal or health care resorts plus vacation rentals. Of late there has also been growth of non-traditional forms of overnight stays offered by individuals or hospitality platforms such as Airbnb.

Many hospitality properties are located near and associated with airports, casinos, entertainment districts, business parks, sports stadiums and convention centers.

Hospitality properties are able to adjust rates quickly to adapt to changing occupancy trends and demand drivers as they offer daily rates. As payments are usually made upfront, collections loss or tenant rental default is not an issue.

Risks: the performance of hospitality properties is affected by seasonal, locational, environmental and amenity factors relative to their competitors and occupancy can change dramatically due to unforeseen events (as with the pandemic).

They are also very management and labor intensive due to high turnover of guest/guests and the rooms and ancillary features need to be marketed 365 days a year to attract new guests. All areas need to be constantly maintained, cleaned and updated to keep pace with occupier demands and the competition.

A knowledgeable and experienced hospitality management team is essential for success.

Specialty real estate

There are many other forms of specialty real estate including raw or undeveloped land, single family home rentals, self-storage, cold storage, manufactured or prefabricated homes, farms and ranches and advertising billboards. Each property type has its own unique strengths and weaknesses, advantages and risks.

Breneman Capital

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We focus on providing our investors with the best risk-adjusted investment opportunities in carefully selected markets across the U.S., researched and underwritten with extreme detail from our headquarters in Chicago.

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