Real Estate, What It Is and How It Works

Four Types of Real Estate

Table of Contents

Updated February 24, 2020

Image shows three clusters of buildings, the first is suburban homes and trees, the second is skyscrapers and office buildings, and the third is a factory. next to the factory is just empty land. Text reads: "what is real estate? real estate is defined as the property, land, buildings, and air rights above land, and underground rights below the land. Residential, commercial, industrial, and vacant land." — Image by Ashley Nicole DeLeon © The Balance 2019

Real estate is the property, land, buildings, air rights above the land and underground rights below the land. The term real estate means real, or physical, property. “Real” comes from the Latin root res, or things. Others say it’s from the Latin word rex, meaning “royal,” since kings used to own all land in their kingdoms. The U.S. Constitution initially restricted voting rights to only owners of real estate.1

Four Types of Real Estate

There are four types of real estate:

Residential real estate includes both new construction and resale homes. The most common category is single-family homes. There are also condominiums, co-ops, townhouses, duplexes, triple-deckers, quadplexes, high-value homes, multi-generational and vacation homes.
Commercial real estate includes shopping centers and strip malls, medical and educational buildings, hotels and offices. Apartment buildings are often considered commercial, even though they are used for residences. That’s because they are owned to produce income.
Industrial real estate includes manufacturing buildings and property, as well as warehouses. The buildings can be used for research, production, storage, and distribution of goods. Some buildings that distribute goods are considered commercial real estate. The classification is important because the zoning, construction, and sales are handled differently.
Land includes vacant land, working farms, and ranches. The subcategories within vacant land include undeveloped, early development or reuse, subdivision and site assembly.2 Here’s more at Land Broker Transactions.

How the Real Estate Industry Works

Real estate also refers to producing, buying and selling real estate. Real estate affects the U.S. economy by being a critical driver of economic growth.

Construction of new buildings is a component of gross domestic product. It includes both residential, commercial, and industrial buildings. In 2018, real estate construction contributed $1.15 trillion to the nation’s economic output. That’s 6.2% of U.S. gross domestic product. It’s more than the $1.13 trillion in 2017 but still less than the 2006 peak of $1.19 trillion. At that time, real estate construction was a hefty 8.9% component of GDP.

New home building is a critical category. It includes the construction of single-family homes, townhouses, and condominiums. The National Association of Home Builders provides monthly data on home sales and average prices. The data on new home sales is a leading economic indicator.3 It takes four months to establish a trend for new houses sold.4

The NAHB also reports new home starts, those are the number of home construction projects on which ground is broken.

Real estate agents assist homeowners, businesses and investors buy and sell all four types of properties. The industry is typically divided up into specialists that focus on one of the types.

Sellers’ agents help find buyers through either the Multiple Listing Service or their professional contacts. They price your property, using comparative listings of recently sold properties known as “comps.” The can help you spruce up your property so it will look its best to customers. They assist in negotiations with the buyer, helping you get the highest price possible. Here are more sellers’ agent services.

Buyers’ agents provide similar services for the home purchaser. They know the local market. That means they can find a property that meets your most important criteria. They also compare prices, called “doing comps.” It allows them to guide you to areas that are affordable. Buyers’ agents negotiate for you, pointing out reasons why the seller should accept a lower price. They help with the legalities of the process, including title search, inspection and financing.

Real estate agents who want to increase their professionalism become REALTORS®. The National Association of REALTORS® provides monthly reports on the number of homes resold and their average price. It’s a better indicator of the health of the overall housing industry than new home construction.

That’s because new home builders can be overenthusiastic about future sales and overbuild. They can also cut prices to force sales. Individual homeowners must follow the market’s supply and demand. They don’t have the clout to manipulate the market. NAR provides the current housing market statistics.

Real Estate Investing

Everyone who buys or sells a home engages in real estate investing. That means you must consider several factors. Will the house rise in value while you live in it? If you get a mortgage, how will future interest rates and taxes affect you?

Many people do so well with investing in their homes they want to buy and sell homes as a business. There are many ways to do that. First, you can flip a house. That’s where you buy a house to improve then sell it. Many people own several homes and rent them out. Others use Airbnb as a convenient way to rent out all or part of their homes. You can rent vacation homes using VRBO or Home Away.

Before you do that, make sure you know where we are in the current business cycle. You don’t want to start potentially risky investing if the real estate market is going to crash.

You can also invest in housing without buying a home. You can buy stocks of homebuilders. Their stock prices rise and fall with the housing market. Another way is with Real Estate Investment Trusts, called REITs. These are investments in commercial real estate. Their stock prices lag behind trends in residential real estate by a few years.

What New Home Statistics Tell You About the Real Estate Market

Statistics about new home construction are important leading economic indicators. That means they will give you a heads up on the future of the housing market.

The chart below illustrates the number of new privately owned housing units started between 2000 and 2019. https://datawrapper.dwcdn.net/c4A38/2/

Each of these indicators tells a little different story about the health of the homebuilding industry. For example, say home starts are steady, but housing starts to decline. That will take a toll on home sales. Many buyers might not want to wait longer than a year. It also means there’s a shortage of lumber, concrete, or construction workers. Those shortages could drive up costs, and sales prices. That would further decrease demand for new homes.

If mortgages are declining, the homebuilder will end up with an inventory of unsold homes for sale. It also means demand is high, but homeowners can’t get mortgages. Rising home starts might seem like an indicator of housing strength. But it might be a bad sign. Declining home closings mean the housing market is weak.

The new home sale is the first step in a nine to twelve-month process. If new home sales pick up, then you know closings will rise in about a year. However, all of the remaining three steps must be completed.

A new home sale is when the buyer signs the paperwork and gives the homebuilder a deposit. That’s because most new homes are not constructed until there is a buyer. The exceptions are spec homes that are used as model homes. The Census Bureau releases monthly estimates of new home sales. They are given as an annual rate.5

Two months after the paperwork is signed, the local housing regulators grant the permit. It is an early indicator, but not always accurate. Builders can go bankrupt and never build the permitted units. They can change the number of units built in a multi-family. In fact, 22.5% of multi-family permits aren’t built, or are changed to single-family units.6 Finally, developers often receive permits for a large portion of a complex that could take months to build.

The new home start occurs next when the builder breaks ground. The National Association of Home Builders reports on this monthly. It’s very accurate because the new home start only occurs when the builder is confident enough to break ground.

Six to nine months later is the closing. The homebuyer must receive a mortgage before the home can close. If the homebuyer doesn’t qualify, the house remains in inventory. If this statistic is lower than the home sale figure, it means the new home market will start to slow down. There are too many homes being built, and not enough qualified home buyers. It can also mean builders will begin lowering prices to clear their inventories.

There are three other important indicators to watch.

Inventory – This is the total of homes that are available for sale, but unsold. The NAHB reports this monthly.
Months of Supply This is how many months it would take to sell all the houses in inventory. It’s based on the sales rate and inventory. The NAHB also reports this monthly.
Sales Prices – The Census Bureau reports on both the median and average new home sales price.7