Amid rising interest rates, inflation concerns, and lifestyle trends that are generating a paradigm shift across the country, many investors are viewing the commercial real estate market with hesitancy.
In March, the Federal Reserve increased the interest rate on reserve balances to 4.9%, making it more expensive for those taking out a loan to borrow money. During the last 12 months, prices in some categories have gone up by more than 10%, with inflation rates hitting the highest level we’ve seen in 40 years, according to the Consumer Price Index. Nearly six out of 10 employees with a hybrid schedule spend at least three days a week working from home, as reported by the Pew Research Center (which is why you see so many office spaces that are locked into their leases sitting empty!).
Despite the uncertainties, there are plenty of opportunities for beginning and seasoned investors in today’s market. The key to finding them begins with a solid understanding of the property types that are available. Often called “asset classes,” each of these categories present specific advantages and potential drawbacks.
In this first article of the series, “Making Investment Decisions In Today’s Real Estate Market,” we’ll look at property types that are available today. I’ll lay out the pulse of the market for each, which can be helpful as you make investment decisions. In the following articles, we’ll dive further into related topics, with the goal of creating a valuable resource you can turn to as you move forward in this space.
Choosing a Property Type
While buildings come in all shapes and sizes, they typically fall into one of four main asset classes. These are multifamily, retail, office, and development (which is sometimes called “land”). Let’s take a brief look at each:
- Multifamily: For commercial real estate, this typically consists of properties with five or more units, such as apartment buildings. For beginning investors, there could be benefits to acquiring a place where you can live in one unit and rent the remainder. In these “live-plus-invest” opportunities, if there are fewer than four tenants you could qualify for a residential home loan. These properties are usually considered the safest investments, as people always need a place to live.
- Retail: This category encompasses everything from the family-run nail salon in a commercial strip mall to household-name brands and big box stores. The rents on these properties are often higher than smaller multifamily buildings. However, entering this space is typically more complicated, as lenders may ask for higher levels of funds and have more requirements for financing. If you only have one or two tenants, and one leaves, it could take some time to lease the space to a new client. When evaluating retail, consider if the tenant is “e-commerce proof,” meaning they draw people into their brick-and-mortar location. This could include restaurants, walk-in clinics, and places that attract consumers looking for an experience.
- Office: The prices for this asset class will often be above others, making it necessary to be well-capitalized to enter. In addition, it could be months (or more!) before these spaces generate income. That’s because office areas may need to be customized or renovated for a tenant. In addition, the high specialization means that if a tenant leaves, it can be tough to find a replacement. In markets with steep competition for tenants (like we’re seeing these months!), landlords may need to offer additional concessions such as months of free rent and TI, which stands for tenant improvements.
- Development: Slated for developers, this asset class generally comes with high upfront costs and long timelines. Acquiring land and building on it is typically a project best suited for experienced, highly capitalized investors. With so many steps involved, from financing to construction to meeting codes and finding tenants, the return on investment may take a few years or even a decade to realize.
In addition to understanding the asset classes available, you’ll want to draw on your background and experience when making decisions. While multifamily, as I mentioned, is often well suited for beginners, you might look to delve into other property types as you build your portfolio. I often find advantages in mixed-use properties, such as a building with retail on the ground level and apartments above.
Having an overview of the property types available is really just the beginning of a real estate investing journey. In the next articles, I’ll lay out other key elements, including the nuances of different property types and the risk levels attached to them. Like other industries, in real estate, the more you know, the greater your chances for ongoing returns and lasting success.