Syndicated real estate investing is found in many different types of properties with multiple subcategories. Each type of property has its benefits and drawbacks. Diversifying the types of property you buy is a terrific way to potentially reduce risk and maximize cash flow.
1. Residential property. Multifamily apartment is currently our favorite asset class. To us, it’s all about risk. Historically, from 1978-2013, it had the second lowest Beta (volatility) of all the asset classes, meaning it went up and down less in value, and it provided the highest overall returns over the past 35 years when considering cash flow and
Historical Property Type Characteristics 1978-2013
|Cash Flow Return||5.9%||4.9%||5.5%|
(1) For each property type shown above, please refer to the definitions offered on this page.
(2) Beta measures the sensitivity of an asset’s total return to the market
Source: https://www.metlife.com/assets/cao/investments/US-CoreRealEstate-PastPresentFutureView_2013.pdfOriginally sourced from NCREIF Property Index Data from Q1 1978-Q2 2013.
When we look at after-tax returns, multifamily apartment can provide the best annual after tax cash flow of any real estate segment due to its shorter depreciation schedule of 27.5 years. All other categories of commercial property use a 39-year depreciation schedule. Residential also includes the subcategories of student housing and assisted living. These subcategories require very specialized knowledge on the part of the Sponsor, particularly assisted living. Assisted living demands that the Sponsor not only run the property, but run an entirely separate, regulated business too.
2. Commercial Office. This category includes office complexes, office buildings, and medical offices. These are usually grouped into one of three categories: Class A, B, or C. These classifications are quite subjective. Class A buildings are considered the best in terms of quality of construction and location. They tend to be newer too. Class B properties might have good quality and construction, but with a less central or attractive location. They tend to be older than Class A properties. Class C properties are basically everything else. Medical office, in our opinion, is a strong category within office, as doctors spend hundreds of thousands of dollars building out their offices and are less likely to move than other businesses. Physicians and other Medical Professionals tend to be more focused on their practices than continually seeking out the lowest rent per square foot in their local communities, therefore tenant retention is usually better in medical office than in other types of commercial office properties. Medical office located coincident to a hospital is ideal.
3. Retail. This category includes shopping centers, strip malls, “Big Box” retail (such as Home Depot), and triple net properties (“NNN”). In DSTs, we also have portfolios of Triple Net properties available. If you’re not familiar with NNN properties, imagine a Walgreens, Auto Zone, or Dollar Store. They are stand-alone buildings with one tenant. In true Triple Net, the tenant is responsible for paying property taxes, maintenance, and insurance (hence the NNN of Triple Net), and the property owner is usually responsible for the roof and walls. When we purchase NNN property, we like to have the corporation behind the retail store as our lease guarantor, not a franchisee. In this way, we can secure a lease backed by the assets of a major firm. That can potentially mean lower default risk. Many people consider NNN investing with corporate- backed leases from multi billion dollar companies to be one of the most conservative ways to invest in real estate. Retail can have higher projected returns than multifamily apartment, but also can present more risk. People need a place to live, but they don’t necessarily need to shop. Adding some carefully chosen retail property to your portfolio can provide diversification and can potentially lower overall risk in your portfolio.
4. Industrial Property. Industrial property is uncommon in DSTs, but it can be a strong category. Following the same logic as medical office, when a business takes an industrial space, they are likely to modify the space to meet their specific needs with an assembly line or manufacturing equipment affixed to the walls, ceiling, and floors. Because of that large financial investment, they are less likely to move and interrupt operations.
5. Hospitality. Hotels and entertainment venues took the biggest hit of all categories in the Great Recession. We understand that hotel prices dropped in value during the Great Recession to the same degree they did during the Great Depression. During the recession, people and businesses simply stopped traveling, and they didn’t start again for many years. In our viewpoint, hospitality as a category carries more risk than most of our investors are willing to accept. This isn’t a Monopoly game—hotels are not the best investments for our clients, in my mind, purely from a risk standpoint.
By Leslie Pappas, Founder and CEO