The first step in real estate investment is choosing a property type. With this in mind, we have identified some of the major differences between five investment property types—residential (single-family and assets with less than five units), multifamily, industrial, office, and retail)— focusing on five key factors of determination. Our examination compares the property types against their ease of financing, operating costs, management, stability of occupancy, and sensitivity to the state of the economy. Each factor has its set of circumstances to consider, so in addition to presenting our findings directly below, we have included a chart in our conclusion, which sums up the results.
Key Issues Factors in Choosing a Real Estate Investment
Financing. Residential real estate stands out in this category. Unlike the other property types, duplexes, triplexes, and fourplexes are financed like single-family residences—that is, with a residential loan. Since home loans are considered less risky than commercial loans, this type of loan is easier to obtain and usually has less complicated conditions. For example, it is sometimes possible to get a residential loan without a down payment, and there is usually no penalty for paying off the loan early. Residential property is likely to be the most affordable per unit, which makes it a good choice for first-time investors.
The remaining types of investment property are financed with commercial loans. Some industrial properties are classified as “single-purpose,” which means they are customized to the extent that they would be difficult to use for anything else and, consequently, potentially challenging to sell. Auto service facilities, funeral homes, and medical centers are a few of the many examples of this type of property. Lenders are less willing to finance the purchase or construction of these buildings because the presumed difficulty in selling them increases the risk. When lenders do finance these properties, they usually require higher down payments and set other conditions that are more difficult to meet than the conditions for non-specialized commercial properties. Warehouses, storage units, and similar non-specialized industrial properties do not face these financing challenges, however, and they are often the least expensive of all types of investment property to build.
Operations. Industrial properties have the advantage when it comes to operations. Maintenance and utilities payments are usually tenant responsibilities. Multifamily properties also rate well here because of the relative simplicity and compactness of a typical property. Office and retail properties are labor intensive, often having more complex systems, such as HVAC and security, that are more difficult to maintain. Tenants also expect great attention to be paid to maintaining the appearance of these properties. Residential properties rank lowest here, because their locations can present issues. For example, each property might require different service providers (plumbers, groundskeepers, etc.), which can drive up prices and complicate accounting. Also, residential properties in many parts of the country provide very minimal cash flow, making these services simply unaffordable.
Management. When it comes to management, industrial properties again have the edge over the other types. They present few management challenges because of the level of responsibility of the tenant. Multifamily, office, and retail properties are most often managed professionally and with high efficiency, relieving owners of the task and often saving them money. Retail properties are considered the most challenging to manage; cash flow limitations can make professional management impractical and, therefore, time-consuming for the owner.
Occupancy. Usually, the fewer pro forma tenants on a property, the more dependent the investor is on each one to remain and provide a stable cash flow. The exceptions to that generality are retail properties, because retailers hate to move, and industrial properties, because tenants often have technical needs so specialized that relocating can be very difficult. For a residential property owner, the departure of a single tenant could mean a major loss of cash flow. Office building investors also have to worry about tenants leaving, but to a lesser degree; businesses move their offices much less frequently than people change residences.
Office and retail spaces are typically leased for many years, whereas residential property is traditionally leased by the year. Long leases help stabilize occupancy, but they also put owners at risk of losing opportunities for increased earnings in a market upturn. When vacancies do arise, office space tends to stay vacant the longest of all property types. Retail space is also subject to long vacancies, and if a departing merchant is the anchor store of a mall or shopping center, it can have a detrimental effect on the remaining businesses Since multifamily properties have many tenants, single vacancies have little impact on cash flow.
The economy. Office and residential properties perform very well in a good economy, as rents can be raised. When the economy sags, single-family properties are at risk because tenants move to apartments to save money. Multifamily property stability during economic downturns is legendary—people hold on to their homes for as long as possible. Retail and office property investors benefit from long leases in a bad economy, since leases prevent tenants from reducing or leaving their spaces, as long as they are solvent. Industrial properties tend to be stable, once again because their single-purpose nature makes it difficult for tenants to leave in any economy.
While every investment is a mixed bag that requires investors to weigh their choices and act according to their own priorities, we see a lot of advantages in multifamily properties. This chart presents our observations more concisely:
At CWS Capital Partners, we are a fully integrated multifamily real estate investment management firm that offers everything from due diligence and risk management to transaction support and property management. We specialize in assisting our clients with 1031 exchanges, acquisitions, repositioning, and development. We also own and manage luxury multifamily investment communities in major markets around the country and employ a team of experts who can help you hone your investment strategy.
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