A Guide to Real Estate Asset Classes
June 20, 2022
Investing in real estate is a great way to diversify your portfolio. But before you invest in real estate, understanding real estate asset classes is important. For example, you can invest in commercial real estate or residential property types to diversify your portfolio.
As you learn how to invest in real estate, you should understand your options in the real estate market to diversify your portfolio enough to reach your financial goals.
What Is an Asset Class?
An asset class is a group of similar investments that react similarly to the market's events and must follow the same rules and regulations. The three most common asset classes are equities, fixed income, and cash equivalents. The types of assets included in these classes are stocks, bonds, and money market accounts.
Investors today, though, are looking for ways to diversify their portfolios. Relying on the stock market has proven too risky for many investors. Keeping your entire investment in one asset class can be risky.
To diversify your portfolio, you might consider investing in real estate. It's in its own asset class that is separate from stocks, bonds, and cash equivalents and often performs opposite of the way other investments perform.
Real Estate Asset Classes
As you learn more about investing in real estate, you should learn about the three types of property classes. Each asset class is based on the property's age and quality. Understanding the types can help investors determine if an investment is worth it financially and how it might perform.
Class A properties are the highest real estate class. The properties are 10 - 15 years old and have above-market rents. Many properties in this class are considered luxurious because of their modern amenities and accessibility to the area. Many older areas are tearing down lower-class buildings to rebuild Type A buildings for higher rental income.
Class B property types are in between Type A and Type C. They are your 'average properties' that may earn average rental income. The properties are usually 20 - 40 years old, the area is accessible, and the home's amenities are average. The tenants Class B properties bring in are still higher end, but not those looking for luxurious amenities.
Class C properties are the lowest on the scale. They are usually the oldest properties and often sell at less than their value. The focus on Class C properties is functionality rather than luxury, as is the case for Class A and B properties.
Types of Real Estate Asset Classes
Aside from the types of real estate investments, there are many different types of real estate classes, each of which has other uses and potential. Understanding the different types of assets can help you choose the right real estate investment strategies to reach your goals.
Commercial real estate properties include typical businesses (stores, office space, etc.) and multifamily properties with more than five units.
As an investor, you rent properties to business owners. Commercial real estate costs more than residential property but can have a higher return on investment because of the higher rents you can charge.
Commercial real estate often has higher risks though, especially during an economic downturn, as businesses often suffer first, leaving commercial real estate investors losing money first versus residential real estate investors.
Multifamily properties with over five units are considered commercial real estate. This can include condos, apartment complexes, or homes with multiple units. You can rent the units to individual tenants and earn monthly rental income.
They aren't considered residential property because it's more of a business with many units to rent.
Retail is a real estate class for any type of store, including individual stores and shopping malls. The property's value varies based on the current tenants, lease agreements, and the business's net income.
Office space is for businesses running an office. It can be one business in an office space or multiple tenants. The office buildings can also be located in almost any type of property.
Self-storage is a newer commercial real estate investment, but it's becoming more popular today. Because of the large number of people moving and even downsizing, the need for self-storage space has increased dramatically. Still, because there are limited facilities, the rental income has increased too.
Industrial real estate is another up-and-coming way to add to your investment portfolio. Industrial real estate can include manufacturing facilities, warehouses, and research and development facilities.
Just be careful since most research and development facilities are built to suit, which makes it hard to re-tenant the facility when the current tenant leaves.
Real estate investors can also invest in land without a building on it. The land can be developed (ready to build on) or undeveloped (not zoned or ready for building yet).
Land is very unique and should be considered carefully before investing because its value can go up or down based on many factors, including zoning changes, the economy, and even natural disasters.
It can be difficult to find a buyer for land, especially undeveloped land, so it's important to have a solid plan for what you want to do with the land before investing.
Residential real estate is one of the real estate asset classes that's easier to invest in because the barriers to entry are much lower. Many real estate investors start with residential real estate when they learn how to invest in real estate.
Single-family homes are a good option for new real estate investors. You own one property - a house, that you rent to a family. You are the landlord and responsible for all aspects of caring for the home and the tenants.
Multifamily properties with four units or less are considered part of the residential real estate property class. You can either live in one of the units or buy the property separate from where you live.
If you are a new investor, you can 'house hack' by taking out an owner-occupied mortgage but renting out the other units. The key is that you live in one unit to get the owner-occupied financing terms.
If you don't live in the property, you can still leverage your investment with a mortgage, but the terms may be a little less attractive than a loan for owner-occupied properties.
Co-ops are units within a development owned by a corporation. Instead of taking out a traditional mortgage, you borrow a share loan that allows you to buy shares in the company.
Condominiums are individually owned units within a larger development. The unit owners share common areas and pay a homeowner's association to help maintain the areas. Before making a condominium a part of your investment strategy, make sure the association allows investors. Some associations only allow a certain number of investors.
Townhouses are a larger version of condominiums. They usually have more outdoor space, including garage space and/or a backyard. Like condos, townhouses have shared areas and association dues, but there aren't usually as many restrictions regarding using townhouses for real estate investing.
Vacation homes are usually situated in tourist areas, such as on the beach or in highly populated areas that tourists travel to often. Therefore, vacation homes, while residential properties, can be a short-term rental property that might be easier to manage for new investors.
What Do Real Estate Asset Classes Mean for Investors?
The type of real estate investment you choose should align with your investment goals. For example, if you're looking for a steady income stream, investing in a multifamily property or townhouse might be a better option than buying a vacation home.
Each asset class has its own set of risks and rewards, so it's important to do your research before investing. Real estate asset classes help investors understand a property's purpose, potential, and overall cost. You can diversify your portfolio by investing in properties in different asset classes including different commercial and residential properties.
Which Real Estate Asset Class Is Best to Invest In?
Many real estate investors prefer to invest in commercial real estate because of its higher cash flow and more stable leases. Commercial real estate leases are typically for 5 - 10 years versus the annual lease most residential properties have. Like any investment, it's best to weigh the pros and cons after learning all the details and potentially getting investment advice from your financial advisor.
The Bottom Line
Each type of real estate asset has its own set of advantages and disadvantages. Therefore, it's essential to do your research and understand the different asset classes before making any investment decisions. However, diversifying your portfolio by investing in different real estate types can help reduce your risk and maximize your returns. Learn more by signing up and visiting our blog.
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