What are the Best Types of Real Estate Investments?

After spending years in real estate, new investors ask me all the time: what are the different types of real estate investment? Which one should I choose to get started?

There are many different types of real estate investments other than just buying and selling. Some have lower requirements so it’s easier for beginners to manage, but some are more advanced and require more experience or funds.

Basically, real estate includes residential and commercial property types. Residential property consists of single-family homes to quadplexes. Commercial property consists of all other real estate (e.g. apartments, offices, industrial, etc). I recommend investors begin with single-family homes, as they require the least cash.

In the following article, I’ll dive into some more details about these different types of real estate investment. Specifically, I’ll cover each of the following topics:

  • Residential: Single-family Homes
  • Residential: “Plexes”
  • Commercial vs. Residential Overview
  • Multifamily Investment
  • Offices Investment
  • Industrial Investment
  • Medical Investment
  • Retail Investment
  • Hospitality Investment
  • Land Investment
  • Best Real Estate Investment Type for New Investors

Residential: Single-family Homes

When new investors think about diving into real estate, they typically look to single-family homes first.

As the name suggests, this category includes residential properties designed to house one family (as opposed to multi-family properties, which I’ll discuss below). Of this class, standalone, single-family houses make up the largest portion of properties. However, the single-family home category also technically includes townhomes and single condos (not entire condo buildings).

For new real estate investors, this category makes the most sense for three main reasons:

  • Cost: Single-family homes typically cost far less than multifamily ones and commercial properties, meaning that new investors with limited capital still have the ability to purchase a single-family rental property.
  • Familiarity: Whether you own a rental property or not, you’ve likely lived in a single-family home at some point in your life. As such, you inherently understand the tenant and general compliance considerations associated with this sort of investment property. On the other hand, understanding the tenant needs of a business occupying office space requires far more research and experience.
  • Availability: The market just includes far more single-family homes than other types of investment properties. For new investors, this availability makes it far easier to find an investment property at your specific A) price point, B) desired condition, and C) location.

Additionally, from a financing perspective, new real estate investors often find the residential mortgage process far easier to understand than the intricacies of commercial lending—typically because they’ve been through this process with their primary residences.

For investors, common investment strategies with single-family homes include:

  • Fix & flip: Buy, rehab, and sell (at a profit) a home in need of repairs.
  • BRRRR: Buy, rehab, rent, refinance, and repeat – this process aligns well with investors seeking a “buy-and-hold” approach to real estate investing.
  • Wholesaling: With this strategy, investors contract a home with a seller but don’t actually purchase the property. Instead, after going under contract, they find a third-party buyer and assign the contract, receiving a fee in the process. This strategy typically involves distressed properties in need of repair.

Regardless which approach you take, new (and experienced) investors need to conduct thorough due diligence in evaluating an investment property prior to purchasing.

Residential: “Plexes”

“Plexes” include multifamily properties that still fall under the residential real estate umbrella. They include the following:

  • Duplex: Two-unit property.
  • Triplex: Three-unit property.
  • Quadplex: Four-unit property.

Once multifamily properties reach five or more units, they qualify as commercial multifamily, which I’ll discuss in the next section.

Frequently, these properties represent the “next step up” for real estate investors. After acquiring a portfolio of single-family properties, many investors decide to test the multifamily waters and purchase a plex. While this makes sense in some situations, prior to committing to this route, investors should consider the following pros and cons associated with this property type.

Pros

  • Vacancy hedge: In a single-family home, if you lose a tenant, you lose 100% of your rental income. With two- to four-unit properties, if one tenant moves out, you’ll still take a big hit to your bottom line, but the remaining tenants will partially offset the vacancy. In other words, you’ll still have some monthly rent payments coming in to pay your operating expenses.
  • Streamlined financing: If you want to buy four single-family homes, you need to apply for and close on four separate loans, which can be an administrative nightmare. Conversely, if you buy a quadplex, you only need to apply for and close a single loan, significantly easing your administrative burden (though the qualification standards will likely be higher for a loan on a quadplex).

Cons

  • Availability: If plexes are so great, why doesn’t every real estate investor just buy a quadplex and call it a day? Unfortunately, far fewer plexes exist in most markets than single-family homes, meaning that investors will face significant competition from other investors when one comes up for sale.
  • Cost: While affordable plexes certainly exist, most of these properties cost significantly more than single-family homes, posing a major obstacle to new investors with limited capital.  Additionally, due to stricter lending standards, conventional mortgages for these properties often require a 25% or 30% down payment (as opposed to the standard 20% down for a single-family home).

Commercial vs. Residential Investment Overview

As stated above, once plexes surpass four units, they become multifamily commercial properties. While these properties include essentially the same tenants, commercial properties use different financing options.

With residential properties, investors generally use personal mortgages, that is, loans borrowed in your own name, not that of a business. This means that you’ll need to qualify with your own credit, income, assets, and debt-to-income ratios. These loan products include the familiar 15- to 30-year mortgages.

With commercial lending, businesses apply for loans (in the case of real estate, investors typically organize properties as LLCs or limited partnerships). This means that the assets of the business, the property’s pro forma financial statements, and the investment track record of the borrower drive approval for commercial mortgages (though new commercial investors will often need to personally guarantee these loans).

Additionally, the actual loan products differ. Whereas personal mortgages align loan term (length of the loan) and amortization (period that a loan’s principal is reduced by payments), most commercial mortgages do not. Instead, commercial mortgages tend to have shorter loan terms (e.g. 10 years) and longer amortization periods (e.g. 20 years).  This means that your monthly payments are made as if you would pay off the loan in 20 years, but at the end of the 10-year term, you’ll owe a one-time balloon payment.

This structure limits the interest-rate risk for lenders but increases this risk with borrowers. If mortgage rates increase by several (or more) percentage points over a ten-year term, commercial borrowers need to refinance into a far worse rate environment.

Multifamily Investment

Multifamily aptly describes this property type—properties that house multiple families. For experienced residential property investors, these properties often represent a great bridge into the commercial real estate world, as you’ll be dealing with the same type of tenants as residential real estate.

Furthermore, multifamily properties continue the vacancy-hedge advantage discussed above with plexes. If you lose one tenant in a duplex, you’ve lost half your rental income—a significant hit to your cash flow. If you lose one tenant in a 100-unit apartment building, you’ve only lost 1/100 of your rental income, a far easier vacancy loss to absorb.

Additionally, multifamily properties provide investors economies of scale advantages. If you need to buy one or two hot water heaters for a single-family home or duplex, you likely won’t receive a vendor discount. But, if you need to buy 100 hot water heaters for an apartment building, you can use that volume as leverage to command per-unit discounts with most vendors.

Large apartment buildings also often have enough cash flow to justify on-site maintenance and management. In addition to increasing tenant satisfaction—and therefore limiting turnover and vacancy—this on-site support drastically reduces the time investors need to pour into a property, freeing them up to pursue other deals.

Major types of multifamily properties include:

  • Garden apartments
  • Mid- and high-rise apartments
  • Student housing
  • Senior/assisted-living facilities

Offices Investment

The next major type of real estate investment includes office buildings, that is, buildings that house business offices. Like multifamily properties, this type of real estate generally offers a vacancy hedge, as most office buildings include multiple units, meaning that if one business leaves, the other office tenants help offset the vacancy hit.

Investors sub-categorize offices based on their age, quality, and location. Class A offices tend to be the newest, highest-quality, and best located; Class B includes mid-range properties; and Class C includes the oldest properties in need of the most repairs in the least-desirable locations.

Major office types include:

  • Central business district properties
  • Houses zoned for commercial use
  • Suburban office buildings

Industrial Property Investment

The absolute variety of industrial buildings makes this property type unique. With residential, multifamily, and offices, investors get pretty standard tenants. Industrial space has a far wider tenant type and actual space use, with each tenant needing a fairly unique property build-out.

However, the unique nature of each of these properties can also make industrial real estate a compelling investment option. Put simply, once an industrial tenant moves into a property, they do enough work that they’re unlikely to want to leave quickly. This reality creates a long-term, stable tenant base.

For new investors, though, the complexities of industrial properties and industrial leases—to say nothing of the massive costs associated with purchasing or developing these properties—can make this sort of investment unrealistic.

The major categories of commercial properties include:

  • Bulk warehouses
  • Commercial flex space (part office and part industrial)
  • Heavy manufacturing plants
  • Light assembly facilities
  • Refrigeration and cold storage
  • Commercial showrooms (part office, warehouse, and retail)
  • Self-storage facilities

Medical Property Investment

Medical properties comprise the next major type of real estate investment. This includes all property types built around the needs of the medical profession, from your local clinic to major hospitals.

Similar to industrial spaces, the stability provided by medical properties makes them extremely valuable to investors. Regardless of economic conditions, people always need medical care. And, once a medical tenant occupies a space, they don’t have much incentive to leave, which leads to long-term leases (10+ years).

Furthermore, medical properties require extremely industry-specific build-outs. For example, hospitals and doctors offices frequently require lead-lined walls, increased plumbing capacity, and wider elevators to support patient movement. All of these characteristics further disincentivize medical tenants from moving once established—a major plus for investors.

Major categories of medical property include:

  • Neighborhood doctor and dentist offices
  • Out- and in-patient surgery centers
  • Urgent care facilities
  • Major hospitals

Retail Property Investment

Retail properties include all spaces designed for tenants who sell goods or services directly to consumers. Think of your local Verizon store, a neighborhood restaurant, or a coffee shop; the properties these businesses occupy all qualify as retail real estate.

Due to the consumer-centric nature of retail, these properties need to be located in places that maximize consumer convenience. It wouldn’t make much sense to have a fast-food restaurant out in the middle of the desert away from any major roads, right?  Consequently, these properties tend to be fairly expensive, as a premium exists on this prime location (though retail spaces certainly exist in less desirable markets, as well).

For investors, the future of retail real estate needs to be measured against the growth in e-commerce. In analyzing potential investment opportunities, investors need to consider the long-term trends associated with the underlying tenant businesses. Whereas product-related retail has suffered with the growth of e-commerce, service-related retail (e.g. hair salons and nail parlors) has tended to thrive.

A wide variety of retail property types exist, with the major ones including:

  • Community retail
  • Outparcel or stand-alone buildings
  • Power center (anchored by a major regional retailer like Wal-Mart or Bass Pro)
  • Regional malls
  • Strip malls
  • Neighborhood retail/shopping centers

Hospitality Investment

Hospitality represents the final major type of commercial real estate. These properties serve the needs of travelers, both for business and pleasure purposes.

For investors, hospitality properties tend to closely mirror the current economic cycle, for better or worse. When the economy performs well, business and pleasure travelers tend to travel more frequently. On the other hand, in economic downturns, both of these types of traveler tend to “tighten the belt” and scale back travel, which can hurt the operating performance of hospitality real estate.

Major hospitality real estate categories include:

  • Budget / low-cost hotels and motels
  • Extended-stay hotels
  • Full-service hotels
  • Limited-service hotels

Land Investment

I’ve included land last, because depending on investor intention, it can lean more towards the residential or commercial category. But, land truly represents its own class of real estate.

In general, three types of land investment exist:

  • Development: With this strategy, experienced property developers purchase land with the intent to actually build a property on that land, either to retain as an income-producing property or sell for a profit.  This type of investing requires significant experience and capital, and it entails a large amount of risk.  For these reasons, I highly advise against trying this for new investors.
  • Speculation: Speculation proves a far simpler process than developing, but it’s not without risk.  Essentially, investors try to purchase a discounted parcel of land on the outskirts of a developed area with the hope that the land will be in the path of development.  That way, as development encroaches, the value of the land will increase, leading to a profit.  However, if development doesn’t end up approaching the land, investors may be stuck with a parcel with limited appreciation potential.
  • Land flipping: Flipping land generally parallels the theory behind flipping houses; it just entails far less work, as investors don’t need to actually rehab land.  These flippers find a parcel of land, make an offer well below tax-assessed value in the hopes of finding a motivated seller, and, if accepted, resell the land for closer to market value – and a profit.

I personally believe investing in single-family homes provides far greater returns than investing in land, but investors can certainly pursue this strategy on the side—and land flipping tends to require far less initial capital.

Best Real Estate Investment Type for New Investors

So, what’s the answer? What’s the best type of real estate investment for new investors?

In my experience, I firmly believe that investing in single-family homes represents the best option for new real estate investors. These properties require far less cash than some of the other property types outlined above, and plenty of them exist on the market.

Furthermore, new investors just tend to be more familiar with single-family homes, making the initial investing learning curve far more reasonable. Conversely, commercial properties tend to include far more complexity while requiring significantly larger initial investments.

And, when it comes to finding solid single-family investment properties, I highly recommend using an investing tool like our Investor’s Edge software. In addition to including a database of millions of homes, our software provides investors the marketing, analysis, and tracking support they need to thrive in the real estate world.

 

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