One question I am often asked about with regards to real estate is: What is the “best” type of property to invest in?
Obviously, there is no right or wrong answer. Your ability to risk the money you invest, the returns you might expect, time horizons, and your overall investment goals all impact what investment might be right for you.
The following factors impact the success of all real estate investments:
4) Necessity for capital improvements
Additionally, the terms of any existing leases will affect a property’s performance. There are, however, some benefits and challenges inherent in various asset classes. Understanding these details can help you assess what type of investment is best to help you meet your goals.
This column addresses the risks and rewards generally associated with residential, retail, office, industrial, and operational real estate investments.
Residential investment properties are attractive because there are a broad range of choices in a wide variety of price points. You can invest in a single-family home, a condominium unit, or a multi-tenant building.
Furthermore, there is a comparatively strong supply of possible residential tenants compared to other asset types. Everyone needs to live somewhere.
Perhaps the biggest challenge with residential property is that it tends to be management-intensive in terms of maintaining the property and collecting rent. If you are not handy, or if the property is not near you, you will likely need to hire someone to handle operational matters for you.
The biggest challenge with residential property is that it tends to be management-intensive in terms of maintaining the property and collecting rent
In addition, units in multi-tenant buildings may be negatively affected by neighboring owners. Residential renters’ appetites for amenities change more quickly than do commercial tenants. On top of that, pricing may be competitive, as you must bid against both prospective investors and prospective residents. [Editor’s Note: The Financial Poise webinar, “Investing in Residential Real Estate” will provide a deeper look into this specific type of investment.]
The following are specific risk factors for residential properties:
Retail and office investments share several similar features. Both can be single- or multi-tenant properties. The tenants may include global, national, or regional firms, as well as “mom and pop” businesses.
The number of tenants and the tenants’ credit and sophistication, as well as the extent of common areas maintained by the landlord will impact the ease of managing both types of properties.
Recent market trends for both sectors include a general reduction in square footage desired by tenants. In retail, this is largely due to internet sales and better distribution channels — resulting in less inventory stored on-site. In office buildings, the need for storage areas for paper files has been reduced significantly by electronic records. Additionally, the footprint of offices has waned as companies have become more open to telecommuting, and have shifted from fewer single-user areas in favor of collaborative common spaces. [Editor’s Note: Learn the ins and outs of this type of investment with the Financial Poise webinar “Investing in Commercial Real Estate“]
As a by-product of telecommuting, space requirements have also been affected by hoteling. This happens when employees reserve desks or offices on a daily or hourly basis when they are physically in the office, using lockers or other designated storage space for files and personal items when they are working remotely.
One of the biggest challenges faced by the retail sector is the impact of e-commerce. While 91.6% of retail sales still arise from brick-and-mortar stores, the future of large retail spaces (such as department and big box stores) is unclear.
One of the biggest challenges faced by the retail sector is the impact of e-commerce.
Some retailers have moved to a showroom model. At the store, customers can see and touch sample products, and then have the goods shipped from a distribution center. In contrast, Amazon has now opened brick-and-mortar stores to supplement its online presence. Learning how to Leverage Real Estate Investments to your advantage could really pay off depending on the timing.
E-fairness legislation is currently being deliberated by Congress to require online retailers to collect sales tax for all customers regardless of whether they have a physical presence in the state. This would eliminate price distinctions due to state and local taxes.
If there are multiple tenants, you may also consider the following additional factors:
Some issues specific to shopping centers include:
Industrial properties include warehouses, distribution centers, manufacturing facilities and flex buildings. Access to transportation is more important for industrial assets than other property types; tenants will need to be able to easily transport materials and goods to and from the facility. Features that warrant special attention when considering an industrial building include:
Operational properties do not get leased to specific tenants. They are instead used by paying customers on a daily, weekly, or monthly basis. Hotels, parking garages, self-storage facilities and some assisted/senior living centers are examples of this asset class.
Unlike residential, retail, office, and industrial properties, the success of an operational property is largely dependent on the underlying business at the property. Income from such assets will change due to seasonal and other variances in business.
No asset class is necessarily “better” than any other for investment. However, some types of properties will need more time and expertise than others to keep cash flowing.
For operational assets, therefore, it is important to have property management with specific expertise in the field who can 1) handle the business on a day-to-day basis, and 2) optimize use while controlling costs. Accordingly, these properties do not make good “armchair” investments without the help of an experienced operator to take on these efforts.
Operational assets are also more dependent on the local economy than other property types. The occupants do not need to ask for rent reductions from the landlord if business is slow; the income adjusts itself based on the market. On the other hand, a strong demand for the property’s services or reduced competition can mean quicker income for the landlord.
No asset class is necessarily “better” than any other for investment. However, some types of properties will need more time and expertise than others to keep cash flowing. Having multiple tenants may increase the operational complexity of a property, but it may also afford more flexibility to adjust rents or repurpose space if needed.
You should always obtain your own market research and conduct due diligence before investing in a property. Reviewing existing leases is a key to understanding the potential benefits and pitfalls of a given asset.
Ideally, passive investors should strive for diversity in their investment portfolios, and rely on knowledgeable property management if issues arise. Mixed-use properties, such as storefronts with apartments or offices located above them, may have both advantages and disadvantages of their component asset types. They also offer a degree of diversification within a single building.
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Tracy is a Principal at Syndicated Equities where she helps high net worth individuals and family offices to profitably invest in real estate. She also assists investors in identifying appropriate replacement property to complete tax-deferred exchanges under Section 1031 of the Internal Revenue Code. Drawing upon her 20 years of legal experience in the areas…
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