Real Estate

What Is Real Estate?

Real estate refers to properties that include land and any buildings or structures on it, as well as natural resources like wild plants and animals, cultivated crops, livestock, water, and any mineral deposits found within the land.

Understanding Real Estate

Real estate is a tangible asset, classified as real property. Examples of real property are land, buildings, and any improvements made to the land, along with the associated rights to use and enjoy the land and its developments. While renters and leaseholders may have the right to occupy land or buildings considered part of their estate, these rights are not, strictly speaking, considered real estate itself.

Real property is distinct from personal property. Personal property includes intangible assets, like investments, and tangible items, such as furniture and appliances like dishwashers. Renters may claim parts of a property as personal property, especially if the item was purchased with the landlord’s approval.

Key Takeaways

Real estate refers to tangible property consisting of land and anything permanently attached to it, such as buildings, plants, animals, and natural resources.
Real estate falls into three primary categories: residential, commercial, and industrial.
Residential real estate tends to be more affordable and accessible to individuals, while commercial real estate is typically more valuable and stable.
Real estate can offer income and capital growth through investment.
You can invest in real estate directly (by buying land or properties) or indirectly (by purchasing shares in publicly traded real estate investment trusts (REITs) or mortgage-backed securities (MBS)).

Types of Real Estate

When we talk about the “real estate market,” we’re usually discussing three broad categories based on usage:

Residential Real Estate: This includes undeveloped land, homes, apartments, and townhouses. The structures can be single-family or multi-family homes and can either be owner-occupied or rental properties.
Commercial Real Estate: This category involves non-residential structures, such as office buildings, warehouses, and retail stores. These properties may be standalone or part of a shopping center.
Industrial Real Estate: This includes properties like factories, business parks, mines, and farms. These are typically larger in size and are often located near transportation hubs, such as railways or ports.

Benefits of Residential Real Estate and Home Ownership

Homeownership is the most common form of real estate investment in the United States. According to the National Multifamily Housing Council (NMHC), around two-thirds of Americans own their homes. Often, these purchases are financed through mortgage loans, where the property acts as collateral for the debt.

In 2019, Zillow reported that the total value of all U.S. homes in 2018 was $33.3 trillion—71% higher than the national GDP at that time.

Those looking to finance their home purchase face various mortgage options, including fixed-rate or adjustable-rate loans. Fixed-rate mortgages tend to have higher initial rates than adjustable-rate mortgages, but they protect the borrower from future interest rate hikes.

Benefits of Commercial Real Estate

Commercial real estate is used for business purposes and includes properties like shopping centers, restaurants, office buildings, and skyscrapers. This category differs from industrial real estate, which is designed for the manufacturing of goods.

Commercial leases tend to be longer than residential leases, and returns are typically based on the profitability of the space per square foot, rather than its suitability for residential use. Additionally, lenders often require a larger down payment for commercial real estate than for residential properties.

Investing in Real Estate

Real estate can be invested in directly by purchasing properties or land, or indirectly by investing in shares of REITs or MBS. Direct investment in real estate generates profits or losses from two primary sources: rental income and appreciation of the property’s value.

Real estate values are influenced by local factors like employment rates, local economies, crime rates, infrastructure, school quality, municipal services, and property taxes. Therefore, location plays a critical role in determining the value of real estate.

Pros and Cons of Real Estate Investment

Pros

Provides steady income
Potential for capital appreciation
Diversifies an investment portfolio
Can be purchased using leverage

Cons

Generally illiquid
Affected by local factors
Requires significant upfront capital
May require active management and expertise

Residential real estate is typically less expensive than commercial real estate and is more accessible for small investors. In contrast, commercial properties tend to have higher value per square foot, with longer leases that ensure a more predictable income stream.

Appreciation

Real estate appreciation is typically achieved through various means, but it is only realized when the property is sold. An alternative way to realize appreciation is by refinancing the property. Raw land, especially outside city borders, has the highest potential for development and profit. Properties may also appreciate due to the discovery of valuable resources like oil.

Income

Real estate generates income in various ways. The primary source of income comes from rents collected on residential and commercial properties. Other sources include royalties from natural resource discoveries and companies paying to build structures like cell towers or pipelines.

Indirect income can also be earned through investments in REITs and MBS. In these cases, property owners sell shares to investors, who receive a portion of the rental income as distributions.

Real-World Examples of Real Estate Investments

Mortgage-backed securities (MBS) were at the center of the global financial crisis of 2007, but they remain a viable investment option today. Investors can access these products through exchange-traded funds (ETFs). These investments provide an opportunity for portfolio diversification but carry some risk.

Top-performing MBS ETFs include:

Vanguard Mortgage-Backed Securities ETF (VMBS)
iShares Barclays MBS Bond ETF (MBB)
SPDR Bloomberg Barclays Capital Mortgage-Backed Bond ETF (MBG)

These funds offer yields ranging from 2.48% to 3.15% and can be a way for investors to gain exposure to mortgage-backed assets.