1. Exploring Real Estate Investments: Introduction
  2. Exploring Real Estate Investments: What Is Real Estate?
  3. Exploring Real Estate Investments: Types Of Real Estate
  4. Exploring Real Estate Investments: Characteristics Of Real Estate Investments
  5. Exploring Real Estate Investments: Advantages And Disadvantages
  6. Exploring Real Estate Investments: Buying And Owning Real Estate
  7. Exploring Real Estate Investments: Finding Investment Value
  8. Exploring Real Estate Investments: Conclusion

By Ian Woychuk, CFA

In the previous chapter, we discussed the various categories of available real estate investments, including direct property ownership, mortgages, and debt or equity securities. What these real estate investments have in common is that there are one or more tangible real estate properties underlying each investment. That means when you make an investment, it is important to consider the characteristics of the underlying real estate because the performance of those properties will impact the performance of your investment.

When you're looking at the underlying real estate, one of the most important criteria (aside from location, location, location!) is the type of property. When considering a purchase, you need to ask yourself whether the underlying properties are, for example, residential homes, shopping malls, warehouses, office towers or a combination of any of these. Each type of real estate has a different set of drivers influencing its performance. You can't simply assume one type of property will perform well in a market where a different type is performing well. Likewise, you can't assume one type of property will continue to be a good investment simply because it has performed well in the past.

Income-Producing and Non-Income-Producing Investments
There are four broad types of income-producing real estate: offices, retail, industrial and leased residential. There are many other less common types as well, such as hotels, mini-storage, parking lots and seniors care housing. The key criteria in these investments that we are focusing on is that they are income producing.

Non-income-producing investments, such as houses, vacation properties or vacant commercial buildings, are as sound as income-producing investments. Just keep in mind that if you invest equity in a non-income producing property you will not receive any rent, so all of your return must be through capital appreciation. If you invest in debt secured by non-income-producing real estate, remember that the borrower's personal income must be sufficient to cover the mortgage payments, because there is no tenant income to secure the payments.

Office Property
Offices are the "flagship" investment for many real estate owners. They tend to be, on average, the largest and highest profile property type because of their typical location in downtown cores and sprawling suburban office parks.

At its most fundamental level, the demand for office space is tied to companies' requirement for office workers, and the average space per office worker. The typical office worker is involved in things like finance, accounting, insurance, real estate, services, management and administration. As these "white-collar" jobs grow, there is greater demand for office spaces.

Returns from office properties can be highly variable because the market tends to be sensitive to economic performance. One downside is that office buildings have high operating costs, so if you lose a tenant it can have a substantial impact on the returns for the property. However, in times of prosperity, offices tend to perform extremely well, because demand for space causes rental rates to increase and an extended time period is required to build an office tower to relieve the pressure on the market and rents.

Retail Property
There is a wide variety of Retail properties, ranging from large enclosed shopping malls to single tenant buildings in pedestrian zones. At the present time, the Power Center format is in favor, with retailers occupying larger premises than in the enclosed mall format, and having greater visibility and access from adjacent roadways.

Many retail properties have an anchor, which is a large, well-known retailer that acts as a draw to the center. An example of a well-known anchor is Wal-Mart. If a retail property has a food store as an anchor, it is said to be food-anchored or grocery-anchored; such anchors would typically enhance the fundamentals of a property and make it more desirable for investment. Often, a retail center has one or more ancillary multi-bay buildings containing smaller tenants. One of these small units is termed a commercial retail unit (CRU).

The demand for retail space has many drivers. Among them are: location, visibility, population density, population growth and relative income levels. From an economic perspective, retails tend to perform best in growing economies and when retail sales growth is high.

Returns from Retails tend to be more stable than Offices, in part because retail leases are generally longer and retailers are less inclined to relocate as compared to office tenants.

Industrial Property
Industrials are often considered the "staple" of the average real estate investor. Generally, they require smaller average investments, are less management intensive and have lower operating costs than their office and retail counterparts.

There are varying types of industrials depending on the use of the building. For example, buildings could be used for warehousing, manufacturing, research and development, or distribution. Some industrials can even have partial or full office build-outs.

Some important factors to consider in an industrial property would be functionality (for example, ceiling height), location relative to major transport routes (including rail or sea), building configuration, loading and the degree of specialization in the space (such as whether it has cranes or freezers). For some uses, the presence of outdoor or covered yard space is important.

Multi-family Residential Property
Multi-family residential property generally delivers the most stable returns, because no matter what the economic cycle, people always need a place to live. The result is that in normal markets, residential occupancy tends to stay reasonably high. Another factor contributing to the stability of residential property is that the loss of a single tenant has a minimal impact on the bottom line, whereas if you lose a tenant in any other type of property the negative effects can be much more significant.

For most commercial property types, tenant leases are either net or partially net, meaning that most operating expenses can be passed along to tenants. However, residential properties typically do not have this attribute, meaning that the risk of increases in building operating costs is borne by the property owner for the duration of the lease.

A positive aspect of residential properties is that in some countries, government-insured financing is available. At the expense of a small premium, insured financing lowers the interest rate on mortgages, thereby enhancing potential returns from the investment.

Exploring Real Estate Investments: Characteristics Of Real Estate Investments

Related Articles
  1. Managing Wealth

    Find Fortune In Commercial Real Estate

    Investing in big buildings means big money - and bigger risks.
  2. Investing

    Exploring Real Estate Investments: Conclusion

    By Ian Woychuk, CFA We've covered quite a few points throughout this tutorial. Below are some of the main points that were made along the way: Real estate investments fall into one of the ...
  3. Investing

    Exploring Real Estate Investments: Characteristics Of Real Estate Investments

    By Ian Woychuk, CFA One of the beneficial features of real estate is that it produces relatively consistent total returns that are a hybrid of income and capital growth. In that sense, real estate ...
  4. Managing Wealth

    Simple Ways to Invest in Real Estate

    Owning property isn't always easy, but there are plenty of perks. Here are some ways to invest in real estate.
  5. Personal Finance

    Flipping Houses: Is It Better Than Buy and Hold?

    Real estate investors can flip a property or use it for cash flow. Find out which will work in your neck of the woods.
  6. Investing

    Understanding Real Estate

    Real estate is an encompassing term that refers to land, the buildings on that land, and its natural resources, such as crops and minerals.
  7. Personal Finance

    How You Make Money In Real Estate

    If you're interested in the real estate game, make sure you know what factors will affect whether you make money or not.
  8. Financial Advisor

    Why Real Estate is a Good Fit for Older Investors

    Real estate investing can be a good fit for older investors. Here are three reasons why.
  9. Personal Finance

    Real Estate Vs. Stocks: Which One's Right For You?

    There are ups and downs for both real estate and stock investments, so before diving in, know the differences between the two.
  10. Investing

    Exploring Real Estate Investments: Advantages And Disadvantages

    By Ian Woychuk, CFA As we discussed in Chapter 1, real estate is usually held as part of a larger portfolio, and is generally considered an alternative investment class. Real estate fits well ...
Trading Center