“Before you start trying to work out which direction the property market is headed, you should be aware that there are markets within markets.” – Paul Clitheroe
First, as a follow-up to Part 2 of this series, my mom thanked me for not directly calling her out as having been responsible for many of the “Home Interiors Saturdays” we endured as children. You’re welcome, mom. 😊
And while we covered general geography, which then led us into the tiers of US cities, I also want to give an honorable mention to another type of locale we ignored. The areas I’m referring to aren’t specifically “tiers,” but they do have direct real-estate implications. They are known simply as “college towns,” and I love them. It probably has to do with having spent my college career at Penn State, where the town of State College, PA, revolves entirely around the school. The university dominates whether Happy Valley is busy (school’s in session), extra busy (football weekends), or a complete ghost town (holiday breaks).
Also, I was fortunate enough to reside in West Chester, PA, for several years after college. Although West Chester University is much smaller than Penn State, the school still plays an integral role in the town. Both hold a special place in my heart, and – despite many differences – these (and other college towns I’ve visited) offer a shared essence. It’s difficult to capture with words but generally includes a vibrant, youthful energy, ample live music, good food options, and often a lively sports scene.
Others (though I have yet to meet them) may despise college towns, and that’s perfectly fine. However, what isn’t up for disagreement is that a) colleges have a significant impact on the local economies and demographics around them, and b) all of the students and faculty need somewhere to live, and that means they present a different lens through which to view real estate opportunities. This need to house students has resulted in a specific segment of real estate, which is called…wait for it…student housing. More on that later.
Markets within markets within markets
Today’s quote is a fantastic jumping-off point for the next phase of this real estate series. Why? Well, because the “location, location, location” adage we’ve previously referenced REALLY oversimplifies the significant number of attributes that one can consider in a real estate transaction. It’s not only the location (e.g., region, state, city, suburb, block, street, etc.) but also the type, quality, and value-creation strategy that ultimately matters – and that’s still ignoring the equally essential realities of the purchase price, financing, and taxation. From here, we’ll continue delving into those topics and more, with an introduction to property types being where we’ll focus our attention today. Here we go!
What’s your type?
When I became increasingly interested in private alternatives (about a decade ago), it was apparent that there’s a massive difference between the property types within the commercial real estate realm. Of primary importance to investors, each carries unique risk/reward attributes, which inherently align with various investment objectives. Considering private real estate to fall within the Alts portion of a portfolio – and, as such, desiring a risk/return profile that is both different and ideally more favorable than what we find in traditional equity and fixed income allocations – my bias has always been toward those property types that can offer less volatile return paths over time.
Crashing is part of cycling
Before we try to delineate between property types that are more cyclical and less cyclical, let’s look at the real estate cycle itself. As outlined in this MasterClass article (where you can garner additional detail vs. my below synopsis), there are four phases, including:
- Recovery (picking up speed): this happens just after the “recession” phase, so the environment should still feel challenging, but there are many deals to be made (i.e., low prices, low occupancies, a lot of supply, etc.).
- Expansion (cruising): this environment feels much more positive and balanced. Demand is strong, but prices are higher, so the upside potential is typically reduced vs. buying property in the recovery/recession phases.
- Hyper supply (speed wobbles): supply exceeds the high demand of the expansion, putting pressure on rents and vacancies. It may feel euphoric, but more likely like things are getting stretched.
- Recession (crash): the environment feels terrible. Characterized by a significant decline in demand, vacancies increase, and rents fall. A great time to make deals if you have the capital, time horizon, and stomach for it.
With the above in mind, more cyclical property types will generally be more affected by the cycle, while more resilient property types can help mitigate that volatility. But that’s not all. The cyclicality itself varies enormously between markets, and this article lays out examples of cyclical (e.g., New York and California), linear (“a smoother ride,” e.g., the Midwest), and hybrid (e.g., Chicago, Seattle) markets. Synthesizing the above, one can imagine that buying cyclical property types in more cyclical markets generally subjects them to a higher volatility profile than that of more resilient property types in linear markets.
So, what are the property types of commercial real estate?
Good question. If reduced to only four categories, you may come up with Office space, Industrial, Multifamily, and Retail. However, if you expand this to eight categories, that list includes multifamily, office, industrial, retail, hotels & hospitality, mixed-use, land, and special purpose. But, even within the eight categories are a ton of underlying segments, giving us at least 30 different types to consider. For today, the main takeaway is that there are A LOT. We’ll spend more time on those and some of their attributes next time.
Until next time, this is the end of alt.Blend.
Thanks for reading,
Steve
