Real Estate: Definition, Types, How to Invest in It

What Is Real Estate?

Real estate is defined as the land and any permanent structures, like a home, or improvements attached to the land, whether natural or man-made.

Real estate is a form of real property. It differs from personal property, which is not permanently attached to the land, such as vehicles, boats, jewelry, furniture, and farm equipment.

Understanding Real Estate

The terms land, real estate, and real property are often used interchangeably, but there are distinctions.

Land refers to the earth’s surface down to the center of the earth and upward to the airspace above, including the trees, minerals, and water. The physical characteristics of land include its immobility, indestructibility, and uniqueness, where each parcel of land differs geographically.

Real estate encompasses the land, plus any permanent man-made additions, such as houses and other buildings. Any additions or changes to the land that affects the property’s value are called an improvement.

Once land is improved, the total capital and labor used to build the improvement represent a sizable fixed investment. Though a building can be razed, improvements like drainage, electricity, water and sewer systems tend to be permanent.

Real property includes the land and additions to the land plus the rights inherent to its ownership and usage.

What Are Types of Real Estate?

Residential real estate: Any property used for residential purposes. Examples include single-family homes, condos, cooperatives, duplexes, townhouses, and multifamily residences.

Commercial real estate: Any property used exclusively for business purposes, such as apartment complexes, gas stations, grocery stores, hospitals, hotels, offices, parking facilities, restaurants, shopping centers, stores, and theaters.

Industrial real estate: Any property used for manufacturing, production, distribution, storage, and research and development.

Land: Includes undeveloped property, vacant land, and agricultural lands such as farms, orchards, ranches, and timberland.

Special purpose: Property used by the public, such as cemeteries, government buildings, libraries, parks, places of worship, and schools.

The Economics of Real Estate

Real estate is a critical driver of economic growth in the U.S., and housing starts, the number of new residential construction projects in any given month, released by the U.S. Census Bureau, is a key economic indicator. The report includes building permits, housing starts, and housing completions data, for single-family homes, homes with 2-4 units, and multifamily buildings with five or more units, such as apartment complexes1

Investors and analysts keep a close eye on housing starts because the numbers can provide a general sense of economic direction. Moreover, the types of new housing starts can give clues about how the economy is developing.

If housing starts indicate fewer single-family and more multifamily starts, it could signal an impending supply shortage for single-family homes, driving up home prices. The following chart shows 20 years of housing starts, from Jan. 1, 2000, to Feb. 1, 2020.2

How to Invest in Real Estate

Some of the most common ways to invest in real estate include homeownership, investment or rental properties, and house flipping. One type of real estate investor is a real estate wholesaler who contracts a home with a seller, then finds an interested party to buy it. Real estate wholesalers generally find and contract distressed properties but don’t do any renovations or additions.

The earnings from investment in real estate are garnered from revenue from rent or leases, and appreciation of the real estate’s value. According to ATTOM, which oversees the nation’s premier property database, the year-end 2021 U.S. home sales report shows that home sellers nationwide realized a profit of $94,092, a 45.3%return on investment, up 45% from $64,931 in 2020, and up 71% from $55,000 two years ago.3

Real estate is dramatically affected by its location and factors such as employment rates, the local economy, crime rates, transportation facilities, school quality, municipal services, and property taxes can affect the value of the real estate.

Investing in real estate indirectly is done through a real estate investment trust (REIT), a company that holds a portfolio of income-producing real estate. There are several types of REITs, including equity, mortgage, and hybrid REITs, and are classified based on how their shares are bought and sold, such as publicly-traded REITs, public non-traded REITs, and private REITs.

The most popular way to invest in a REIT is to buy shares that are publicly traded on an exchange. The shares trade like any other security traded on an exchange such as stocks and makes REITs very liquid and transparent. Income from REITs is earned through dividend payments and appreciation of the shares. In addition to individual REITs, investors can trade in real estate mutual funds and real estate exchange-traded funds (ETFs).

Another option for investing in real estate is via mortgage-backed securities (MBS), such as through the Vanguard Mortgage-Backed Securities ETF (VMBS), made up of federal agency-backed MBS that have minimum pools of $1 billion and minimum maturity of one year.4 or the iShares MBS ETF (MBB) which focuses on fixed-rate mortgage securities and tracks the Bloomberg U.S. MBS Index. Its holdings include bonds issued or guaranteed by government-sponsored enterprises such as Fannie Mae and Freddie Mac.5