Property investment has always been a millionaire’s secret to success. If you are reading this article, then you are already well aware of that fact. However, did you know there are many ways of being successful through property investment?
Generally, there are 5 main types of property investments, Residential, Commercial, Industrial, Raw Land and REITs. Residential properties are considered the best with the flexibility to long and short rental terms. Fixing and flipping older homes can also give a good capital return.
If you are asking which of the 5 main types of property investments is the best, you will realise that there is no straightforward answer to this question. How each of us invests in real estate closely relates to our take on life and knowing the advantages and disadvantages of each type of investment property will help us identify what best suits our needs and preference.
5 Main Types of Property Investments
What is the best type of property investment? The answer to this question will always be relative as it depends on who is asking the question and the results he is looking for. There are a plethora of things to consider such as your investment strategy, goal as well as your financial status. An investor looking for a short term yield will not likely pick the same property a long term investor will.
While some investors plan their property investment strategy around long-term passive returns and capital appreciation, there are also others who choose to treat it as a business for short term rental, exchanging investment passivity for better rental yields. Other than that, the investor’s knowledge of the market and economic environment he is in will also determine which type of investment suits his portfolio.
So, based on your ideal investment strategy and risk appetite, you are the only person who can determine the best type of investment property, for your portfolio.
Below is a list of each type of property investment and its advantages and disadvantages, and what makes it optimal as an investment.
- Residential Real Estate
- Commercial Real Estate
- Industrial Real Estate
- Raw Land Development
- Real Estate Investment Trusts (REITs)
#1 Residential Real Estate
Residential real estate can be considered the best when it comes to property investments for amateur investors. These are typically known as rental properties where you get to collect rent passively while you wait for the capital appreciation. If you have less than 2 mortgage loans to your name, it is possible for you to obtain a higher financing margin (of up to 90%) as compared to the other forms of property investments, reducing your upfront capital to a minimal level.
While there has been a lot of hype in the market about rental properties, it is important to know that becoming a landlord will not give you immediate results. This is because most of the rental income that you collect off your property is contributed to the monthly mortgage instalments, maintenance cost, property tax and on some occasions, towards the management body of your residential compound. Hence, residential real estate is indeed a good property investment, but only in the long run.
Advantages
Becoming a landlord for long term rental properties is one of the most common ways to passive investment. If you looking to live on a monthly income from your rental property, you can either choose to pay cash for the property or to leverage less from the bank. By reducing the monthly instalments, a higher capital upfront is required in exchange for more monthly cash flow.
There are also those who choose to run their rental properties like a business, similar to those in the hotel industry through platforms such as Airbnb. This business model does yield better rental returns but it generally involves more commitment on your part, not yet considering the higher cost to market the unit and maintaining the property. In most cases, property investors will either build a business system around it or opt to hire property managers to run the Airbnb business.
Those who can manage this portfolio appropriately can stand to make a significant amount of passive income while they sleep.
Disadvantages
What you need to know about being a landlord is that it can be challenging when your portfolio scales up. It is easy to manage 1 or 2 rental properties, dealing with the tenant and their demands. However, if you have a portfolio of 20 – 30 properties, it can become really demanding and loses its lustre as a passive investment. In such cases, it is ideal to hire a property manager to manage the properties on your behalf, freeing you and your time for other more important matters.
Other than that, it is also really important to choose the right tenant portfolio for your rental properties. As a landlord, your rental income is highly dependent on the punctuality of your tenants as a paymaster. If they are consistently behind on rent, you might have to pursue legal action or even evict them for non-payment. All these can become an unnecessary hassle and financial expenditure.
#2 Commercial Real Estate
How I view property investment is the same as how I play a game. This is essentially a game of life where you start from ground zero with little to no capital and you build your portfolio into the big league. Commercial real estate is the next step in my property investment portfolio. Some of the best commercial properties to consider is retail, hospitality and office.
Advantages
One reason commercial properties are considered the big league in real estate investments is the potential for higher cash flow. The typical profile of tenants for commercial properties is business owners looking to run a successful business. This also means they are like to stay longer with longer leases and lower vacancy rates over the long term.
Unlike residential properties, landlords for commercial properties do not typically need to furnish their properties for the tenant. Most of the furnishing and renovation works are done by the tenant who runs the business out of the property. This also means a lower cost to manage the commercial property, yielding higher returns as compared to residential properties.
Disadvantages
When it comes to owning a commercial property, one of the main setbacks is the higher upfront capital expenditure. Unlike investing in residential properties, the typical margin of financing from banks is less than 80%. As an investor, you will need to fork up 20% of the property value which is also much higher than the typical rental property.
While the leasing period for commercial properties is typically longer with a 3-year tenancy + a 3-year renewable agreement, looking for a tenant to rent your retail lot can be a challenge of its’ own. The demand for retail lots is definitely less compared to residential properties because not everyone wants to run a physical business. Hence, it becomes increasingly important to invest in commercial property at a good location with high foot traffic and consistent crowd throughout the day.
Landlords for commercial properties typically enjoys a good life during the best years of the economy. However, during an economic downturn such as a pandemic or a market crisis, most landlords will suffer a tough time collecting rent from their tenants and to further extend the lease. I have seen landlords with commercial properties in their portfolios helping tenants to survive through the tough times by giving discounts on the lease and providing a private moratorium.
If you are a property investor looking to diversify into commercial properties such as retail lots and office space, it is really important to save up for the rainy days. If you do not have enough cash to survive through the tough periods, it is quite possible to end up bankrupt once the crisis is over.
#3 Industrial Real Estate
When we talk about industrial real estate, we are considering properties such as warehouses or small generic factory lots that can be rented out easily for small-time manufacturers. It is indeed a very niche market that requires specialised professional help to maintain and manage, not to mention the significantly higher capital expenditure to own the property.
Advantages
Traditional office space and retail lots can typically yield anywhere between 4% to 6% on investment. On the other hand, industrial properties such as warehouses can provide a better promise on return of up to 8%. Owning a commercial property does come with its fair share of overheads – upgrades, repairs and minor renovations. However, in industrial real estate, the maintenance required is far less than commercial properties because industrial properties are really basic with big open areas with concrete floors and exposed ceilings. In some cases, zinc roofing with little soundproofing and insulation.
With the growing demand for eCommerce, the demand for warehouses has also grown in the past number of years. Collaborating with logistics companies as their distribution centres can be a good source of income, especially when there is a long term agreement. Other than the straightforward leasing business model, investors can also consider doing a profit-sharing model with upstart logistics company to yield better returns in the longer term.
Disadvantages
On the flip side, not all industrial properties are in demand. If the warehouse is designed terribly, it can be a grave financial disaster. Failure to account for sufficient loading bays, disproportionate office-to-warehouse space ratio, massive warehouse beam and insufficient electrical power can be detrimental to industrial property.
It is important to understand your target tenants’ focus when investing in industrial real estate. Business owners looking to rent an industrial space will focus on the highest and best use of the industrial property, aiming to achieve the highest commercial efficacy. Not being able to accommodate this cardinal rule will leave your industrial property vacant for an extended amount of time, setting you back significantly on your investment portfolio.
Hence, if you are looking to diversify into industrial real estate, it is important to really study and understand the current economic trend. Understanding that the current market is moving towards logistics and delivery services, you will want to pick an industrial property that can fulfil this need efficiently.
#4 Raw Land Development
Looking for raw land to invest in the city can be really difficult especially when land is scarce. However, investing in land can be a really attractive way to diversify an investor’s portfolio. Raw land refers to any vacant land available for purchase and can be used for unique opportunities not available to other forms of property investment.
A good example of raw land investment is agricultural land. The global market size for the agriculture industry is estimated to be worth at least $8 trillion in value – contributed by a growing population and a diversification in diet. As a property investor in agricultural land, this figure is indicative of the global need for more food today, more than ever. We will likely see a growing demand for agricultural land for farming and livestock in the near future.
Other than agricultural purposes, it is also possible to act as a small-time developer in constructing your own development, be it a low-rise apartment or a bungalow. With extensive market research and preparation, it is possible to make a good return from the sales of properties on your land. For investors looking to purchase land within the city, it is also possible to create a parking business for office districts with high demand for parking lots.
With that said, raw land investment is indeed very unique as compared to residential and commercial properties. Like a blank piece of paper, you as the investor get to decide what the land can be used for, either for agricultural, development or even small-time parking business. However, I cannot emphasize enough, it will demand a lot of market research and understanding of the business world to truly appreciate the long term investment value.
#5 Real Estate Investment Trust (REITs)
Investing in Real Estate Investment Trust (REITs) is an indirect way to diversify into Real Estate. It is equivalent to buying shares of a corporation that owns real estate properties. As an investor, you benefit from dividends and capital gain matching the desired industry without the added risk of owning the property yourself.
Advantages
Most REITs company behaves like a scaled-up version of a property investment portfolio. Their business model revolves around leasing space and collecting rent on the properties under their management, the generated income is then paid out to shareholders in the form of dividends. It is a requirement for REITs to return 90% of their taxable income to shareholders every year.
Because of the diverse portfolio managed by these REITs companies, you as an investor is effectively diversifying your portfolio without taking on additional risk. Hence, it can be a really lucrative idea to include REITs into your portfolio of investment, having diverse returns without the added risk and hassle.
When it comes to physical real estate properties, it is unlikely for you to liquidate your rental properties in a rush without lowering prices. This is different with publicly traded REITs as they offer investors liquidity. You can sell your shares of the company on the stock exchange whenever you need emergency funds.
Disadvantages
When you invest in residential or commercial properties, you have a great deal of control over the returns. You decide the cost of renovation, the tenant portfolio and rental yield. However, when you invest in REITs, you have no control over how these properties are being managed. If you are upset with the performance, the only thing you can do is to sell the shares.
On the other hand, the dividend from REITs is taxed at the regular income tax rate. Unlike residential properties where you get to offset the mortgage instalments, maintenance and government tax in your income tax filing, REITs dividends do not have such an advantage. Hence, it becomes more expensive to participate in such an investment.
In some cases, there are REITs company that charges high transaction and management fees, leading to lower dividend yield for shareholders. If you are not careful, you might miss these transaction fees hidden in the fine print of the offering. This is especially true for private REITs where the transaction and management fees are not made publicly available.
Focusing on Residential Real Estate
Residential real estate is the most common form of property investment, both for veteran and amateur investors. With the rapid rise of digital applications such as booking.com and Airbnb, property investors are now given multiple options to run their rental properties.
Below are some of the common strategies when it comes to investing in residential real estate,
- Long Term Rental
- Short Term Rental (Airbnb)
- Fix and Flips
- BRRRR (Buy, Rehab, Rent, Refinance, Repeat)
#1 Long Term Rental
Long term rental of a year or more provides investors with stable secure cash flow. It does not offer high attractive yields but it definitely gives you peace of mind. One of the biggest advantages to long term renting is having a guaranteed monthly income from your tenant which can be really helpful in navigating through some of the toughest times in the market.
While long term rental does not give a high attractive yield, it is possible to increase rent especially when the economy is good. On the flip side, investors should also be prepared to negotiate their rates in a bad market. After all, it is better to retain a tenant through the tough times than to pay out of your own pocket.
When it comes to administrative and maintenance, having a long term tenant really helps in keeping costs down. Every time you list your property on the market, it involves advertisement, maintenance, and paperwork cost which can easily be 1 – 2 months worth of rent.
To put into perspective, if you have a long term tenant of 10 years, you are essentially spending 2 months’ worth of rent to gain 120 months’ worth of income, minus the miscellaneous spending along the way.
The main focus for Long Term Rental
In the long term rental strategy, it is ideal to seek tenants that are motivated to stay in your property for an extended period. While it is important to find the right tenant profile, it is also important to be the right landlord for your tenants. In my opinion, long term rental is the same as building a relationship with your tenant, treat them right and they will stay put for a really long time. Giving you the sweet sweet passive income, without hassle.
#2 Short Term Rental
Short Term Rental strategy is becoming increasingly popular over the last few years with the help of Airbnb. This allows property investors to rent out their properties for short getaways or business visits, anywhere from a night to a few months.
One of the key benefits to short term rental is the higher rent per night. If you have a residential property in a popular tourist area, it is possible to make a lot of money if you keep it booked throughout the month. The rental yield can be anywhere 2 – 3 times more than the long term rental.
The biggest downside to short term rental is the turnaround time. If you have a property that is really popular, you will need to have a cleaning team capable of setting up the place in a short time. Not to mention, the cleaning cost will also add up really quickly. On some rare occasions, you will also have unruly guests who will not care for the property, damaging your furniture and creating a mess. Even though companies such as Airbnb can reimburse you for the damages, it is just a hassle to deal with.
The main focus for Short Term Rental
You will need a business system to manage these short term rental properties. A team capable of managing the high volume of guest enquiries and a good cleaning team is crucial to this business.
#3 Fix and Flip
If you are not into managing tenants but still keen on having a short term investment, then the fix and flip is the best for you. This involves the process of buying a really run-down property, renovating or rehabilitating it, and selling it back at a higher price. While fix and flip can be considered the best short term investment because of their high return on investment, they do have very high costs associated with them and require extensive planning to pull off successfully.
Due to their sub-optimal condition, fix and flip properties generally have a low entry price. However, uninitiated investors will themselves operating in the red if they do not account for renovation and repair costs to get the property back into a habitable and attractive condition. Having a good network of suppliers and contractors can be really helpful when it comes to negotiating these costs, keeping the invested amount at a lower sum.
The main focus for Fix and Flip
To really do well with this investment strategy, you will need to have a group of suppliers and contractors who can help you accomplish your goal in a short time at a reasonable cost. If the cost to rehabilitate the home is too expensive, it is unprofitable as an investment. On the other hand, if it takes too long to rehabilitate the home, then you are losing money on the monthly instalments to the bank.
Besides that, you will want to focus on marketing the property when it is about 80% – 90% completed. Having room for potential buyers to dictate the final touch up works can really help to seal the deal.
#4 Buy, Rehab, Rent, Refinance and Repeat (BRRRRR)
The BRRRRR method is essentially the fix and flip with a twist. Instead of selling the now rehabilitated property, the whole intention is to rent it out as quickly as possible. Buying and rehabilitating a property keeps our capital expenditure down while renting it out gives us the monthly rental income.
At the same time, the now rehabilitated property will have a better market value which allows us to refinance it. This gives us spare cash that can then be used to refinance the next property. Hence, it is called the BRRRRR method.
Final Word
Because of how diverse the real estate industry can be, there is no definitive way to decide which type of property investment is the best. As mentioned earlier, it is all relative to the investor and his preference of what works for him in his investment portfolio. If you are an amateur investor, then it might be ideal to consider residential properties as a start. Once you have got the financing working in your favour, perhaps it is time to start diversifying into commercial properties or even industrial properties.
If you are the kind of investor who likes the yield a rental business can provide but not the hassle, then you can consider REITs. REITs can be a good investment tool but it does take away the power a typical property investor will have over their real property investment.
Until then, take care.
