Five Under-the-Radar Real Estate Sectors
It's not all about multifamily and logistics
Over the past six months, the Thesis Driven Developer Database has documented almost active 3,000 real estate developers across 42 different sectors of real estate. While some sectors—multifamily, industrial, retail, office—get the majority of the attention, developers have built great businesses in other overlooked niches. Today’s letter will explore five of those categories.
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Now let’s dive into a handful of the categories most often overlooked:
1. Medical Office
See the developers building Medical Office in the Thesis Driven Database
Medical office buildings (MOBs) provide patient care, office, and laboratory space for the health care industry. They are often—but not always—located near hospitals, which often act as master tenants of nearby MOBs.
The medical office market has bucked a broader trend of pain in the office world. “Work from home” isn’t particularly applicable to most medical office tenants, and the sector has shown resilience through economic downturns as well as the pandemic. Unlike the office sector as a whole, Medical office buildings (MOBs) have demonstrated stability in rent collections and maintained low vacancy rates compared to other sectors. Even during the Great Recession, MOB vacancies did not exceed 10.4%.
In terms of returns, medical office properties provide some of the best risk-adjusted returns in real estate. Development spreads have remained steady, and the sector has seen continued growth in recent years with $26 billion invested in the medical office sector in 2022 alone. While 2023 saw a step back in transaction volume, medical office fundamentals remain strong, with occupancy rates consistently around 92% for over a decade.
Key players in the medical office real estate development sector include specialized healthcare real estate investment trusts (REITs), private investment funds, and pension funds. Healthcare Realty is the largest pure-play medical office building REIT, while others like Ventas include medical office within a larger healthcare-related portfolio. But new entrants are making significant moves in the market, with MedCraft Investment Partners launching a $500 million fund dedicated to medical office acquisitions and Kayne Anderson Real Estate closing a $2.5 billion fund in 2021, half of which is devoted to medical offices.
2. Military Housing
See the developers building military housing in the Thesis Driven Database
Private military housing development began in earnest with the Military Housing Privatization Initiative (MHPI), a program initiated by Congress in 1996 to address the inadequacy of Department of Defense housing— for example, a $20 billion maintenance backlog which would have taken an estimated 30 years to address with traditional methods.
The MHPI allowed for open competition among developers to operate and maintain housing communities on military installations, leading to the construction and renovation of over 125,000 homes to date and saving taxpayers billions by leveraging $4 billion in government funding into more than $32 billion in private funding. Today, private Military Housing Partnerships own and operate 99% of military family homes on installations across the country.
Unlike in traditional multifamily, delinquency and bad debt is almost nonexistent in military housing. The financial stability of military housing is dependent on the Basic Allowance for Housing (BAH), which provides service members with compensation to cover local housing costs—often covering up to 95% of rent. The MHPI’s Tenant Waterfall Policy further mitigates risk, ensuring the ability to maintain occupancy rates and financial stability even during force realignments and service member declines.
Many traditional multifamily developers also have significant military housing businesses. Balfour Beatty, for example, owns more than 43,000 military housing units across 55 separate military installations. However, prospective military housing developers should be aware that operating military housing puts them at risk of federal scrutiny. For example, Clark Realty Capital executives were called to Capitol Hill to testify, publicly criticized by the military, and forced to sell their portfolio due to poor management practices.
3. Infrastructure
See the developers building infrastructure in the Thesis Driven Database
Infrastructure development is a broad category of real estate that includes the construction of public works like mass transit, airports, power plants, roads, schools, parks, and more. Infrastructure projects usually feature the government as a client and primary stakeholder.
While infrastructure development is well off most real estate developers’ radar, it is one of the few sectors of real estate that has shown continued growth through 2023 fueled by increased public sector spending unlocked by 2021’s Infrastructure Investment and Jobs Act and other, smaller bills on both the federal and state levels.
Typically, standalone infrastructure development happens via RFP (request for proposal) processes, although some infrastructure construction gets negotiated in to large development agreements in exchange for various concessions from government; for example, a rezoning may require a developer to widen a street or build a new mass transit station.
But in an RFP process, developers must submit bids (typically) to the public authority running the process. The issuing authority evaluates the bids based on predefined criteria, which usually include project cost, developer's experience, technical capability, financial stability, and compliance with legal and environmental norms. Statistical data and performance metrics are often used to objectively assess and compare the bids. Before a final winner is selected and a contract is awarded, top respondents will often go through several rounds of negotiation with issuer.
While expertise in infrastructure can insulate a developer from downturns, it’s not a straightforward path: RFP processes can take years, and governments prefer to work with developers with a track record of building infrastructure. But governments are increasingly aware of the need to level the field and encourage new entrants. Set-aside programs for small businesses, new entrants, and minority- and women-owned businesses can give developers without a lengthy track record a fighting chance.
4. Covered Land, Land Banking, and Land Development
See the developers doing land development in the Thesis Driven Database
Covered land investing, land banking, and land development are three different angles of one strategy: investing in under-developed land with the goal of developing it or selling it to a developer at some point in the future. Each term, however, has its own meaning:
Land Banking: This is the practice of buying land as an investment, holding onto it for future sale or development. During the holding period, the land may not be developed and remains unused. Investors bank on the land increasing in value due to factors like urban expansion, development trends, or changes in zoning laws.
Covered Land: This term generally refers to land that is currently being used for a purpose that is less valuable than its potential use. For instance, a small retail building on a large plot of land in a rapidly developing area could be considered covered land. While the current use may produce some cash flow, the primary business model is the appreciation or eventual redevelopment of the underlying land.
Land Development: This involves the process of buying land and making improvements on it to increase its value. Improvements can include things like installing sewer, water, and electrical lines, building roads, or even constructing buildings. This process can be complex, requiring navigation of zoning laws, securing permits, and possibly dealing with environmental issues.
While lucrative, investing in land is perhaps the riskiest development activity we’ll discuss here. Unlike other assets like multifamily and retail, the relatively weak cash flow from raw land means that land developers’ business plans hinge upon some future event, whether that’s a rezoning or simply increased development interest in the specific area.
Land investment requires local expertise and is usually led by GPs and investors with deep familiarity in a given area. This is especially true of land development projects which require working with local government to secure rezoning, entitlements, utility connections, or access improvements like road construction.
Local expertise is also helpful in recognizing the path of development and identifying any obstacles that might stand in the way—for example, an obstinate landowner or a nearby livestock farm. With that in mind, the vast majority of GPs in the Thesis Driven database doing land development are small, local groups preparing pieces of greenfield land for single-family home development, either selling the lots of end users or homebuilders or developing the homes themselves.
5. Life Science
See the developers building Life Science in the Thesis Driven Database
Life science real estate is the development of laboratory, R&D, and office space tailored to the needs of life sciences companies in fields such as biotechnology, pharmaceuticals, medical devices, and some food products. Like medical office, life science development has benefitted from the strength of the sector and the relatively small impact of work from home on life science companies.
Life science development isn’t cheap; laboratory fit-out costs alone in key markets like Boston, San Diego, and the San Francisco Bay Area can reach far above $1,000 per square foot, significantly higher than standard office buildings due to the sophisticated mechanical, electrical, and plumbing engineering required for life sciences facilities.
Alexandria Real Estate, an early mover in the life science real estate market, is the largest owner of life science real estate today, including the 1.3 million square foot Alexandria Center on the east side of Manhattan. But healthcare REITs like Ventas and Healthpeak also have growing life science portfolios; Ventas has been particularly active with significant acquisitions such as the South San Francisco Genesis portfolio. Healthpeak made major investments in life sciences, including in Waltham, Massachusetts, and a significant portfolio in Cambridge.
Blackstone has also emerged as a major player in life science, buying a $3.45 billion life science portfolio from Brookfield in late 2020. Blackstone’s life science development arm, BioMed Realty, is building 2.3 million square feet of life science space in one South San Francisco campus alone. Other emerging players in life science include IQHQ and Tishman Speyer, along with Bellco Capital-backed Breakthrough Properties, which have raised substantial funds for investing in life science real estate.
Like much of real estate, life science development has declined in 2023 as end users focused on profitability and pulled back from new investments. But macro trends are in life science’s favor: with an aging global population and an increasing share of GDP going toward healthcare, the demand for new drugs, devices, and medical innovations is unlikely to slow down.
6. Car-Light Communities
See the developers building car-light communities in the Thesis Driven Database
Open space, walkability, and gentle density are increasingly seen as key ingredients for building a successful new community. We explored the rise of car-light neighborhoods in Thesis Driven last year, featuring projects including Bozeman’s Blackwood Groves and Florence, Alabama’s West Village. As young people increasingly reject driving—with a growing number not even getting their drivers’ licenses—offering freedom from cars is viewed by some developers as a compelling design and marketing strategy. After all, the most trendy and expensive neighborhoods in the US—from Boston’s Beacon Hill to New York’s West Village to Seattle’s Capitol Hill—put cars in the backseat.
Of course, car-light communities still have to have an answer for getting their residents to jobs and amenities. In the few places in the US with good transit, cars simply aren’t necessary. But developers building in other locations must get more creative, betting on bike paths, new streetcar lines, and rideshare partnerships. And skeptical lenders must be convinced as well that buyers and renters will accept housing with little or no parking.
But despite the challenges, car-light designs are gaining attention and traction. And this isn’t just happening at a neighborhood scale; New Urbanist new-build towns like Seabrook, Washington also embrace car-light principles, ditching on-street parking and wide streets for narrow paths, alleys, and sidewalks. Car-light concepts have even attracted venture interest, with walkability-focused developer Culdesac raising a $30 million Series A in 2022.
When traditional projects aren’t penciling, developers are forced to get creative. Familiarity with real estate niches and special use cases like the six sectors we’ve outlined here offers an advantage to any developer willing to think outside the box. We will keep exploring new sectors and analyzing off-the-beaten-path real estate business plans as we grow Thesis Driven and our Developer Database.
—Brad Hargreaves
Nice piece Brad. Hadn’t looked into military housing. If it’s on-base, seems nearly risk free - tenant has perfect credit