Leveraged Breakdowns

REPE Interview Prep: Why Invest in Real Estate? What are the main real estate sectors, and how do they differ?

This is a collection of repe interview questions to help you prepare for a career in REPE. These particular repe interview questions focus on two common questions. First, why invest in real estate? Second, what are the main real estate sectors, and how do they differ? You need to have the answers to these questions cold if you want to land a career in REPE.

Why invest in real estate?

Bullet answer: (i) tangible asset class, (ii) can invest across the capital stack, (iii) more liquid options today than ever

There are three main reasons for investing in real estate. First, it’s a tangible asset class that has been around forever. Second, real estate investing can take place in many parts of the capital stack. From credit investing to equity ownership, there are many ways to participate in the fixed income streams that real estate provides. Third, there are more liquid options today for owning real estate: REITs, real estate equity or debt funds, public companies with a sector focus, real estate private equity, and so on. The combination of smaller check size and better liquidity continues to open up real estate as a viable option to more and more investors.

What are the main real estate sectors, and how do they differ?

Bullet Answer: four main sectors are office, industrial, retail, and multifamily. They differ by intended use, lease term, mark-to-market of revenues and expenses, capital expenditures, and cap rates.

There are four main real estate sectors: Office, Industrial, Retail, and Multifamily. The most obvious difference between each sector is its intended use.

Another difference is lease length, in order of longest to shortest: industrial, office, retail, then multifamily. Because of the differences in lease term, their revenues and expenses also mark-to-market differently each year.

Another key difference is capital expenditures: on a per square foot basis, industrial tends to be the least expensive, then office, then retail, and the most expensive is usually multifamily.  Of course, depending on location and tenant, retail can get far more pricey than multifamily, but as a sector, multifamily is the most capital intensive, especially when you consider the tenant turnover and resulting unit refreshes needed.

Finally, cap rates tend to be lowest for multifamily, office is a little higher, then industrial and retail. Prior to 2019, retail used to be lower than industrial, but retail is so out of favor that cap rates have really shot up in the past few years.

Beyond the four largest sectors, there are others, such as hospitality, data centers, healthcare, self-storage, and timber.

Want to learn more? Read our article, “Five Food Groups of Investment Real Estate

Diving Deeper on Mark-to-Market of Revenues

Lease term affects mark-to-market because leases define the rental rates and expense reimbursements at a fixed point in time. The market for those types of leases can change, but the landlord and tenant have no ability to reset the terms to match the current market until the lease expires. For example, on a 15-year industrial lease, rent and expense reimbursements are set (unless it’s a net lease). If the market shifts to higher lease rates during that 15 years, the landlord has no ability to capture those higher rents until the existing lease expires. In multifamily, however, where leases tend to be 12- to 24-month terms, the landlord has much more ability to reprice the leases. Depending on the direction of the market, this can be a good thing or a bad thing.

Ready to learn more? Dive into our flagship course, Breaking Down Real Estate Private Equity, where we teach you to think like a megafund REPE investor.

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