If real estate investment is something that interests you, here's a guide to understanding the 4 main types of investment real estate as you get started.
Investing in real estate is a great way to diversify your investment portfolio with assets that are less correlated to the equity markets. However, real estate is a broad category, and as you probably expect, there are significant differences in the types of investment properties. For example, commercial and residential real estate both produce income, but their markets are very different. Undeveloped land, meanwhile, can provide big opportunities later down the road if you find the right project or buyer—but it can also be risky.
Exploring real estate as an investment is a smart first move. The second step—educate yourself on the types of real estate you can invest in, and determine which makes the most sense for your goals, needs, and risk tolerance.
Residential Real Estate
There are multiple types of residential real estate including single-family homes, condominiums, vacation rentals, small multi-family units and more. Take note: apartment buildings are considered commercial real estate, even though they are residences. Each type of residential real estate provides a unique investment opportunity as well as an obligation. For example, you may be interested in acquiring single-family homes in order to rent them out. Doing so will generate monthly income (via the rent) that can help pay off the mortgages. However, managing rental properties does entail a fair amount of work and expense. You’ll need to account for finding tenants, making repairs, and managing the home(s).
Vacation rentals could also provide income. Instead of finding tenants, you need to find customers—something made easier by several online vacation rental platforms. That said, you'll still want to ensure steady traffic through your rental and either hire a company to manage the cleaning, booking, and checkout services or commit the time to do it yourself. Lastly, some residential investors see the potential in fixing and then flipping properties. If you can identify up-and-coming neighbors and are willing to put in the sweat equity to save money on the work, you can buy a home at a low price, improve and resell it for a profit.
Commercial Real Estate
At first glance, investing in commercial real estate is more expensive and complex than investing in residential properties. That’s true when it comes to purchases property, but there are other ways investors can access commercial real estate including via REITs, ETFs and crowdfunding platforms. Commercial real estate refers to any property that serves a business—such as retail, restaurant, hotel or office space—and generates income. Within the category, however, there are many sub-types of commercial real estate to consider such as classes of offices and types of retail. A medical building, for instance, if very different from a street-level retail store.
Investors can turn a profit on commercial real estate both by making money on the income the property produces via leases and from the appreciation of the property once it's resold. Most investors do aim to hold commercial real estate holdings for several years at the minimum (unless you’re investing in a more liquid asset such as a REIT or fund, which allows you to buy and sell shares as needed). So as you consider commercial real estate, keep in mind the extended time period for the full return of your capital, and whether that works with your investment goals.
Industrial Real Estate
Industrial real estate is technically another form of commercial real estate, but it’s different for a few reasons. Industrial real estate refers to property leased to industrial businesses such as manufacturing, distribution or warehousing companies. The properties are typically in less desirable areas that are zoned (in most U.S. cities) for industrial-type activities. You can often spot industrial property on the sides of freeways, in ports, or near other transportation hubs.
Investing in industrial property is a costly endeavor as a solo investor—the properties are usually pretty large in size, and thus expensive. That noted, because of their use, the leases are often long-term, more than five years and maybe 10 or more, depending on the nature of the business and property. Industrial property tenants are also more stable and the turnover is less than commercial or residential tenants.
However, this asset class does have some drawbacks. For instance, your tenants’ business is tied directly into the property and its capabilities. Your leases may depend on keeping your building updated with new technology and efficient floorplans. In addition, there are sometimes environmental risks with manufacturing-related businesses. You’ll want to understand how your tenants mitigate their environmental impact and how their use of your property impacts it.
Vacant property can be a great investment—but without any buildings to lease, it doesn’t generate income post-purchase. Your return will only materialize if you develop the land for business or resell it and make a profit off the property appreciation. Undeveloped property is typically less expensive than developed property. What’s more exciting is that you get to execute your vision for what it could be, provided you stay within local land use and zoning requirements. The challenge of a vacant property is that it can be harder to finance; you’ll typically need to finance it yourself. In addition, the process of developing property can take years, especially if you need to obtain permits and licenses for the type of buildings you want to construct.
Investing in real estate is a smart move. By understanding the different types, you can better asses which makes the most sense for your means, portfolio and long-term financial goals.