Intro – Real Estate Asset Classes
Commercial real estate is attractive due to its potential to produce returns for investors uncorrelated from public markets while providing the security of a physical asset. Further, multi-tenant commercial real estate asset classes (by definition) offer a more diversified tenant mix than single-family home investments. This can potentially reduce vacancy risk during times of market upheaval. It is important to distinguish between the many types of commercial real estate, as they carry different benefits and strategic considerations. Depending on your investing goals, the types of real estate you are investing in—or real estate asset classes—can present their own unique set of risk/reward profiles.
The commercial real estate market is divided into six primary asset classes: residential, office, industrial, retail, and hospitality. Within each asset class, properties will be graded by quality (i.e. Class A, B, C, etc…) driven largely by age and upkeep as well as sub-divided by business plan (e.g. within residential there are multifamily rental, for-sale condo and even student housing or age-restricted housing). In recent years, a number of alternative real estate asset classes have drawn increased interest from institutional real estate investors. We will address a broad array of property types in this series, as well as “capital types” across the capital stack and the three Approaches offered by EquityMultiple.
Macroeconomic factors impact each commercial real estate asset class in a different way. While all real estate asset classes can offer an attractive risk/return profile uncorrelated to other investments, each has benefits and drawbacks, and should be considered in the context of your portfolio and long-term strategy. Understanding these dynamics can help contextualize the professional underwriting provided by EquityMultiple on each Offering Page.
Part I – Approaches
Part II – Capital Types
Part III – Property Types
Part IV – Further Reading
Feel free to skip ahead to the material most relevant to you in the table of contents above. We will now take a brief look at major real estate asset classes:
Multifamily properties represent the most primary sector of real estate as they fulfill an essential function of the built environment: providing people with a place to live. Because residential real estate is a staple of daily life, it is also the most intuitive asset class to understand. Well-selected multifamily properties are attractive to investors because of the built-in, natural demand for housing in all forms and, with regards to multifamily rental properties, an attractive hedge against inflation in the form of industry-standard annual rent increases.
Multifamily investments are attractive in markets that are supply-constrained. Strength in an underlying economy is often due to population growth and/or shifting demographic trends.
Office investing provides some of the most stable returns available among real estate asset classes. The long-term nature of the underlying leases (often 5-10 years) provides office owners with predictable, stable cash flows.
During economic expansions, companies tend to hire and expand, creating more demand for office space, particularly in knowledge sectors like finance, IT, and consulting. Investors often consider net absorption of office space in conjunction with overall market occupancy metrics to assess the appeal of an office real estate market. These dynamics also inform judgments on how properties will perform upon lease expiration and renewal.
Industrial real estate has historically yielded stable returns, due primarily to the long-term nature of underlying leases and relatively low overhead costs. Industrial properties range from warehouses to large-scale ecommerce sorting facilities to specific tenant-driven uses such as cannabis facilities. As technology and lifestyle efficiency increasingly dominate tenant demands, higher ceiling clear heights and super-flat floors have become increasingly important property attributes.
Performance of the industrial asset class has historically tracked closely to the manufacturing sector—growth in manufacturing or positive trends in international trade benefit industrial real estate. In recent years, the continued growth in ecommerce has boosted demand for industrial space. Particularly, attention paid to so called “last mile” distribution has sparked a need for industrial real estate increasingly close to population centers.
So long as there are consumers, the retail asset class will remain relevant. Despite retail activity tracking closely with the health of the overall economy, retail leases are often some of the longest in duration, providing investors with stable, long-term cash flow. While ecommerce initially adjusted the tenant demand dynamic this pendulum is now swinging back with even the likes of Amazon opening brick and mortar. Traditional regional malls, however, continue to struggle to find a path forward.
Consumer confidence drives retail activity. Hence, this leading indicator has historically provided a barometer for demand in the market for retail space. In recent years, the ascent of ecommerce has forced retailers to create more experiential, tech-connected shopping experiences in order to stay relevant.
The hotel sector can often provide outsized returns in growing economies. When investing in hotels, having the right operator can be even more important than location as a hotel is a hybrid in the real estate world equally a physical asset and an operating business at the same time.
Hotel asset class performance metrics (like REVPAR meaning Revenue Per Available Room) track closely to the health of the overall economy. Business activity and leisure travel drive demand for hotel rooms, not only pushing occupancy and average room rates but demand for new development as well.
Developers respond to pent-up demand for a particular asset class in a local economy. Development projects are considered the riskiest on the spectrum of real estate investment strategies, but can offer the greatest potential return.
Development is driven entirely by supply and demand for certain product in the market. Due to the complexity and scope of most development projects, timing with respect to the business cycle and an experienced developer are paramount.
Commercial Real Estate Project Types
Within these asset categories, not every project is created equal. Risk and return profiles can vary greatly within an asset class based on geographic market, the stage of development or management of the asset, and the structure of the project’s financing and investor payout. The project’s business plan generally tracks with the following types and will also be classed as A, B, or C which generally refers to a property’s age and maintenance status.
|Stabilized, cash-flowing properties that are over 90% leased and generally operating optimally while commanding top of market rates. Typically located in primary markets with strong fundamentals, the property does not require significant upgrades.||Population growth is expected in a given market, and average rents are expected to rise. Given the straightforward business plan, these property types generally carry less risk and generally yield lower investment returns.|
|Located in primary or secondary markets, and between 75 and 90% leased, at or below market rates. Generally, to increase occupancy and rates, the properties require some moderate capital expenditure.||With expiring leases and upgrades, rent can be increased moderately, presenting upside for investors with limited business plan risk.|
|Located in primary, secondary, or tertiary markets, the property generally leases at large discounts to market rates. Major upgrades to both interior and common areas are needed in order to compete for renters/tenants and achieve market occupancy.||Much like value stocks, these assets are underpriced for their potential and therefore produce low initial returns but can deliver substantial upside if upgrades are effective. This increased risk of business plan execution can produce outsized returns for investors.|
|Starting with undeveloped land or underdeveloped sites in urban infill settings, these sites will have entitlements for the construction of multifamily, office, retail, and/or industrial end uses.||While there is significant risk in ground up construction, the successful completion delivers top of market improvements which will attract tenants at top of market rates. There is not only business plan risk in the completion of construction, but also the risk to lease or sell the final project starting from empty. As such, these project types can carry both significant upside and downside.|
The EquityMultiple Strategy
We select investment offerings that carry the potential for attractive risk-adjusted return for investors, the kind that have historically been available only to professional and institutional investors with the ability to deploy millions on single opportunities. In many cases this will entail a business plan targeting substantial cash flow early in the term or involve a legal structure guaranteeing investor cash flow during the initial improvement period. The majority of projects we select will be in primary or secondary markets. Investment offerings span asset classes and project types.
Above all, we believe that partnering with experienced sponsors and lenders is key to mitigating risk.
Diversifying Your Real Estate Portfolio
Commercial real estate has always been a difficult asset class for individual investors to access due to its capital-intensive nature: oftentimes, you need significant capital outlays to be part of a real estate investment. EquityMultiple provides exposure to a range of approaches, real estate asset classes, and strategies to facilitate building a real estate portfolio that aligns with your overall investing objectives.
EquityMultiple allows you to participate in high-quality commercial real estate investment offerings at relatively low minimums, facilitating diversification across property types and investment strategies.
Up Next >>> Our Three Investment Approaches
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