A Comprehensive Guide to Investing in Physical Real Estate Versus Other Types of Real Estate Investments (REITs, REIGs, Private Notes & More)

Editor’s Note: This article was updated on July 13, 2023.

Investing in real estate is a time-tested strategy for building wealth and generating passive income that also represents a more secure and resistant investment avenue than stocks, for example. But, getting started in the diverse landscape of real estate investment types can be overwhelming for both beginners and seasoned investors.

That’s because each of the different types of real estate investments — be they the various types of property investments in physical real estate or the many different types of real estate investment that don’t require actually owning real property — come with their own challenges, benefits, considerations and strategies that can also change over time.

Investing in Physical Real Estate

Single Family Homes

Single family homes are exactly what they sound like: A single, detached structure designed for one family. They are, by far, the most common type of property investment, especially for beginners. They’re easy because there’s just one unit to manage — one flip, one tenant, one purchase, one sale. An additional advantage compared to other types of real estate investment is their ubiquity: Banks are used to financing these types of mortgages, and contractors are used to remodeling them.

Often, it’s also easier to find tenants for single family homes than it is for apartments. The quality tends to be better, too: Tenants take better care of the property and tenant turnover is also lower, thereby providing income stability. Single family homes also tend to command higher rents than traditional apartments, leading to more income. And, because the market is large, single family homes tend to appreciate, which then generates more equity in the property over time.

In fact, single family homes have become such a popular investment asset that real estate investment trusts (REITs) have been buying them up by the thousands, and developers and a host of investors have gotten into the build-to-rent trend in the single-family market. Consequently, what was a small niche only a few years ago has become a major trend in single-family investment, joining the more established buy-to-rent and house flipping trends.

Vacation Rentals

Single family home investments can also take the form of vacation rentals. Vacation rental property investments are the same as own-to-rent single family homes, with the crucial differences being that they need a good location in popular destinations and require more work from the owner (or a paid employee) to manage, clean and fix the property between guests.

Accessory Dwelling Units

Accessory dwelling units (ADUs) can also be a solid start in real estate investment. These consist of small living spaces located on the same plot as a single family home and usually consist of converted sheds or basements; garage apartments; tiny homes; or container homes built with the purpose of renting them out for additional cash flow. Although less profitable than a fully detached house rental, ADUs also come with lower costs and risks.

Small Multifamily Properties

Small multifamily properties are defined as two- to four-unit properties, like duplexes, triplexes and quads. One of the most attractive aspects of small multifamily properties as a type of property investment is that they are no different from single family homes in terms of financing, which makes the process straightforward and easy.

Notably, the market for small multifamily investment is more limited than single family homes, but investors also don’t have to compete with homebuyers for this asset type. In this case, the main benefit of this type of property investment is rent generation. Accordingly, with ease of financing and multiple tenants paying rent, small multifamily properties can be quite lucrative. As such, these are quite common among mom-and-pop investors and beginners. It’s also common for the owner to live in one unit of the building and rent out the others, thus also acting as a superintendent and maintenance manager.

Large Multifamily Properties

Classified as any property with five units or more, the large multifamily classification covers a wide array of property types. For example, a smaller row of seven townhomes and a 450-unit complex both fit into this category. But, investing in a large multifamily property or complex requires lengthy real estate experience and a high net worth.

Specifically, valuing these assets is significantly different from single family homes and small multifamily properties. The main reason is that the income they produce must be incorporated, which makes financing more complex and downpayments much larger.

That said, large multifamily properties generally provide steady cash flow and have lower vacancy rates than small multifamily assets. At the same time, though, they also have a higher tenant turnover than single-family assets, as well as significantly higher management and maintenance costs. Alternatively, investors who are considering large multifamily properties for investing — but are reticent about the workload that comes with this type of property investment — can:

• use agile property management software to simplify operations
• hire a property manager
• or sign with a property management company

What’s more, considering declining homeownership rates, large multifamily assets remain a reliable long-term investment, especially in large urban centers.

Mobile Home Parks

Mobile home parks somewhat imitate large multifamily properties, with one crucial difference: Tenants own their homes and rent the parcel of land their home and outdoor space are situated on. Generally, each plot will come with a pre-poured cement pad for a mobile home to be placed on by residents. Mobile home parks also vary in size, from just a handful of plots to sprawling parks that contain several dozen plots.

Granted, this type of property investment may come across as less glamorous than other assets, but it can also be a lucrative business — especially in regions where there’s an acute need for affordable housing. Furthermore, upfront costs for mobile home parks are quite low compared to other asset types: Investors only need to buy a plot of land where zoning restrictions allow this property type, then pour the cement pads and run utility hookups to the pads.

Plus, mobile home parks have high cash-on-cash returns with the most significant disadvantage represented by high tenant turnover. However, careful preparation and a well-planned tenant retention strategy can minimize risks and expenses and increase returns.

Vacant/Raw Land

Investing in vacant land is very straightforward. If you’re investing in urban or suburban areas, your investment returns are based solely on the appreciation of value of the land. Alternatively, you can also buy vacant land and rent it out for usage, such as farming. Or, if the plot is wooded, you may be able to sell the timber, as well, if local regulations allow it. 

It’s worth noting that investing in vacant land has very low operating expenses, as well as the potential for high returns and development flexibility (within the limits set up government authorities). But investing in vacant land is not for everyone: These are high-risk investments with extended holding periods that provide no cash flow until the right opportunity comes along.

Commercial Real Estate

Commercial properties are assets that are leased to businesses and can vary widely in style and use. Everything from a warehouse to a strip mall to an office building is considered commercial real estate (CRE). Due to the lower turnover of tenants, these assets can provide more reliable income than asset types relying on everyday consumers as tenants — but they also come with higher risks.

And, because commercial properties have a similar financing structure to that of large multifamily asset, commercial real estate also falls into the category of property investment types intended for experienced investors with significant funds at their disposal.

Commercial Real Estate Types to Consider:

Industrial

Currently, industrial real estate is one of the most sought-after and best-performing real estate asset type in the U.S. More precisely, e-commerce has long been driving growth in the industrial sector, especially in the form of distribution centers and warehouses.

However, the onset of the pandemic and subsequent surge in e-commerce supercharged industrial assets. Therefore, while profit margins have become somewhat slimmer, investing in industrial assets remains comfortably profitable.

Retail

E-commerce has taken a significant chunk out of brick-and-mortar retail and the sector was hit hard during the earlier days of the COVID-19 pandemic. However, it has since rebounded, with destination and lifestyle retail particularly popular.

Office

Just a handful of years ago, office was considered one of the strongest types of real estate investments with steady, reliable yields and a solid outlook. Then, COVID-19 changed everything as the world almost instantly shifted to work-from-home policies — policies that have stuck around and have become the norm across large swaths of job sectors connected to offices. Now, most companies have work-from-home and hybrid work policies, which has led to sharp drops in demand and occupancy rates in the office sector, as well as a looming increase in mortgage delinquencies.

Coworking

Although coworking remains a niche sector of CRE, its presence and popularity has surged after the early days of the pandemic as companies and workers sought smaller professional spaces to meet in, as opposed to using large, open-plan, traditional office spaces.

Currently, both remote workers, as well as companies, are making use of coworking spaces. Some companies have even given up their traditional office footprints altogether, securing long-term memberships in coworking spaces, instead. All of this points toward steady growth in the coworking sector.

Hospitality

Another category severely affected by the pandemic, hotels and other hospitality properties (like resorts and casinos) are yet again seeing visitors flock back to them. It must be noted, however, that hospitality remains vulnerable to health emergencies, travel restrictions, long-term effects from natural disasters and economic downturns.

Health Care

Demand for health care spaces remains high and is expected to continue to grow, especially as the nation’s aging population grows in numbers. On top of that, the continuous expansion of new health care technologies, specialties, and preventative medicine is also driving growth in the sector and is expected to do so for the foreseeable future.

Additionally, medical facilities typically enter into long-term lease agreements with health care providers, thereby ensuring a consistent rental income for property owners. And, unlike other types of commercial properties, health care tenants tend to be more resilient during economic downturns as health care is an essential service that remains in demand regardless of economic conditions. In fact, even in the office sector, markets with large medical office footprints have fared noticeably better than those without a dynamic bioscience presence.

Self-Storage

Still a fairly small industry, the self-storage sector continues to emerge as a highly profitable and sought-after asset class. Accordingly, the steady growth in recent years is expected to continue and demand still outpaces supply by significant margins in most markets. That also ensures high occupancy rates and steady cash flow, especially because maintenance and operation costs are minimal.

Investing in Non-Physical Real Estate

Beyond the different types of property investments in physical real estate, there are also a variety of other modes of real estate investing:

Real Estate Investment Trusts

Real estate investment trusts (REITs) are publicly traded investment companies that pool money from a host of investors to buy, own and manage income-generating properties, later disbursing profits to shareholders. What’s unique to REITs is that, for tax purposes, they’re required to return 90% of their yearly net income to shareholders in the form of dividends. They also trade like stocks. So, as long as you have a brokerage account, REITs are one of the easiest ways to invest in real estate without actually owning physical real estate.

Moreover, REITs are quite diverse: You can find REITs that are specific to the real estate sector — like health care or industrial properties — or others that specialize in a certain investment strategy, like development or net lease. Before buying into REIT, though, investors need to keep in mind that they have no control over what asset types and which properties the REIT chooses to invest in.

Real Estate Investment Groups

Real estate investment groups (REIGs) are similar to REITs, but instead of handing over funds to a trust, they take a more collaborative and direct approach to real estate investment: REIGs pool finances from a group of investors and buy properties collectively. So, not only do REIGs operate with shared ownership, but they also spread the investment risk to all group members.

A major advantage of REIGs is that they provide access to properties that individual investors may not be able to access by themselves. Additionally, in order for a REIG to be successful and profitable, there needs to be precise investment objectives, healthy conflict management strategies and clear decision-making processes.

Private Notes

To invest in private notes, you need to have a significant amount of cash that you’re not using. That’s because you essentially become the bank by lending to others. Private notes are used to offer loans either to developers or other real estate investors. By providing a mortgage to someone, you collect monthly payments and interest on the invested funds. You also retain all of the rights that any other bank would have, such as the right to foreclosure should the borrower fail to make payments.

Crowdfunding Platforms

Crowdfunding platforms facilitate investors to pool funds to invest in real estate properties and projects that would not be available to individuals. As such, they have the potential for high returns, but also come with significant risks. Similar to REITs, they do not offer any kind of ownership in physical real estate.

The major attraction to crowdfunding platforms is that they have lower financial entry barriers compared to REITs or REIGs. From this perspective, they fall into two categories — crowdfunding platforms that only serve accredited investors and platforms that accept nonaccredited investors, as well. Accredited investors are individuals or spouses with a net worth. Specifically, the investor needs to have earned at least $200,000 in at least one of the past two years, with the minimum threshold rising to $300,000 when investing with a spouse.

Notably, platforms that also serve non-accredited investors tend to have a higher risk. These often come in the form of REITs that are not publicly traded, which tend to be highly illiquid. That means that invested funds may be locked in for several years, thereby preventing investors from pulling their money. It’s also worth keeping in mind that crowdfunding platforms are a new approach to real estate funding, having appeared after the 2008 crash. Thus, they have yet to be tested in an economic downturn, further raising the risk of this type of investment.

1031 Exchanges

A 1031 exchange allows investors to redirect a portion of their tax bill from the sale of a property and reinvest that money into a similar property within a specific, predetermined timeframe. A common investment approach in certain areas of the country (such as New York City), 1031 exchanges could soon undergo significant reforms at the behest of the federal government.

Conclusions

The real estate market offers a wide range of different types of property investments that present diverse opportunities and unique challenges, whether you choose physical real estate or other modes of investing. Each asset class has its own benefits and considerations catering to different investment goals, risk appetites, time constraints and financial capabilities.

Another advantage of real estate investment is that it’s generally a good hedge against inflation. However, real estate investments also tend to have high transactional costs — especially legal and brokerage fees — and often require significant amounts of capital, thus limiting the pool of investors.

Before investing, it’s crucial to thoroughly research and analyze the target market; consider property management requirements; evaluate tenant quality and lease terms; and understand the specific risks associated with each asset type. A well-diversified real estate portfolio that combines different asset types can help mitigate risks and enhance long-term returns. As always, consult with real estate professionals and financial advisors to ensure that you make informed investment decisions.

Disclaimer

Information provided on this page is purely informational. It is not and should not be regarded as investment advice.