What are the 5 major real estate asset classes and how much do they yield?

Real estate asset class

4 minute read

An asset class is a group of financial instruments that have comparable characteristics and exhibit similar behaviours in the marketplace. 

Real estate is an asset class that is often categorized under the larger umbrella known as alternative assets. Similarly to stocks and bonds, the real estate asset class is divided into several subclasses according to the key characteristics of the assets in the subclass.

Real estate is traditionally divided into the following asset subclasses:

Office

Office properties lease space to companies so they can operate their business. The leased space includes space for employees to work, for meetings, for events, or for other purposes. Office buildings can range from a single small building with a few employees to high-rise office buildings with tens of thousands of square meters of leasable space and multiple tenants. Office properties are typically leased for the long-term (although the lease terms are becoming shorter now) so they are attractive to investors who are looking for more certainty around long-term cash flows.

The current West-European prime office yields are around 2,6-3,3%, the respective yields in East-European countries are around 4,5 – 6%.

Retail

Retail property is a property that is used for marketing and selling goods and services to consumers. Retail property can be a small cafe in the suburbs or a major shopping centre with hundreds of thousands of square meters of leasable space. SImilarly to office properties, retail offices are leased for the long term, thus providing stable cash flow to investors.

The European retail prime high street yields remain between 2,8% and 3,75%, the prime shopping centre yields are somewhat higher, between 4,25% and 7%.

Industrial and logistics

Warehouses, manufacturing and storage buildings, and distribution centres are all part of the real estate’s industrial and logistics subclass. The majority of the industrial and logistics real estate is used for manufacturing and distribution of the products and is therefore usually located close to main transportation hubs or corridors like ports, airports, train stations or highways. Industrial properties usually have long-term leases and are often occupied by a single tenant or several large tenants rather than a highly diversified tenant mix.

The European industrial and warehouse yields are currently between 3,35% in Germany and 8% in Bucharest.

Residential

Residential properties are dwellings that are typically occupied by individuals or families. Residential real estate includes a wide range of properties, from private houses to townhouses to rowhouses to multifamily apartment buildings. Residential real estate is something that each private person has a relationship with, either as an owner or tenant. As people will always need a place to live, residential real estate is less sensitive to economic downturns.

Due to the low risk, the European residential yields remain below 5%, the lowest being 2% in Turkey and the highest being 7% in Ireland.

Hospitality

Hospitality properties include hotels, motels, luxury resorts, and event centres, usually leased for a single night or for short blocks of time, such as a few days or a week. This allows hospitality-focused properties to increase rates quickly in periods of high demand, but also means that revenue could drop significantly during market downturns, natural disasters, or any number of other reasons.

Due to the ongoing COVID-19 pandemic, the hospitality investments are very depressed and the recent hotel deals have been concluded at around 2% yield.

Do not confuse real estate asset class for the property class

As described above, the property asset class is focused on the use of the property.

Property class refers to the quality and functionality of the property. Classes are usually defined as a Class A, Class B, or Class C property with Class A representing the highest quality and Class C representing the lowest quality.

There is no universally applicable system for determining the class of a property, but some generally accepted principles regard the physical condition and the level of modern functionality the property provides to tenants. For example, a brand-new office building developed with all the latest technology and conveniences would likely be classified as a Class A while the building constructed 50 years ago with no internet access or elevator would likely be classified as a Class C.

Summary

  • Each of those 5 major real estate asset classes have distinct risk and return characteristics;
  • Some of the those 5 real estate asset classes are more open to the influences of the macroeconomic cycles than the others and this is reflected in their return expectations;
  • Unless you have a specific reason to focus on a particular real estate asset class, diversification across multiple real estate asset classes makes sense;
  • Do not forget about the geographic diversification as well – invest in different countries to minimize the risks and maximize your returns.

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