What is Commercial Real Estate

“Commercial real estate” is a confusing term. It does seem self-explanatory, but it’s an overly broad term that includes various property types and sizes. 

In this blog, we’ll clear it up and define “what is commercial real estate” in the broadest sense. We’ll also go into the details concerning common property sizes, types, and uses. Additionally, we’ll tell you about how to invest in it and mention the pros and cons of going down this road. By the end, you’ll have a thorough understanding of what commercial real estate is all about and can use the info to determine whether it’s a good fit for your investment portfolio. 

Understanding Commercial Real Estate 

Fundamentally, commercial real estate means properties that produce income and are used primarily for business purposes. They’re usually bought for investment purposes and provide a return through a combo of rental income, price appreciation, and tax benefits. 

Then again, as we described in the introduction, this definition is just too broad and doesn’t account for the significant nuance in commercial properties. To be precise, they can be further broken down into property types and building classes. 

Types of Commercial Real Estate 

A real estate broker California can provide you access to 8 types of commercial real estate properties. 

Retail

Retail properties are typically located in shopping areas of cities, and they contain customer-facing businesses. These businesses sell goods and services that we use in our daily lives. Common retail properties include: 

• Strip and Shopping Centers: As the name suggests, strip centers are smaller shopping centers arrange in a “strip” and mostly include tenants like clothing stores, coffee shops, or quick service restaurants. Larger shopping centers may contain an anchor tenant, who is a large, well-known tenant. This anchor tenant keeps the property “anchored” by attracting shopping traffic and paying most of the rent. 

• Community Retail Centers: These large properties often range from 125,000 to 350,000 SF. They usually contain several anchor tenants. Such centers are quite common in the suburbs of many cities. 

• Shopping Malls: There’s a classic shopping mall in almost every major city in some shape or form. These establishments contain several anchor department stores and many interior stores and restaurants. On the small end, a shopping mall could be 300,000 or 400,000 SF. An incredibly large shopping mall could occupy 1,000,000 SF or more. 

• Outparcels: Certain retail properties have “outparcels,” which are basically small parcels of land within the boundaries of a larger retail property. Often, they’re developed for a tenant that has a complementary use to the others in the “inline” space. Examples include bank branches, drug stores, or quick-service restaurants. 

Real estate investors favor retail space for their highly visible locations, long-term leases, and diversity of the tenant base. 

Office Buildings

Office buildings are a part of what is commercial real estate. They’re properties where companies can operate. These establishments range from general purpose office space, like the ones used by architects or accounting firms, to highly specialized places like medical offices or light manufacturing plants. These could be small, single-story properties located in the suburbs or multi-story high-rise buildings that are so common in central business districts of cities. 

Office buildings are preferred for their long-term leases, high-quality business tenants, and the scale that comes with having all tenants within a single property. Management is easier in office buildings. 

Industrial Properties

Industrial real estate is appropriate for storage, manufacturing, and logistics. These types of properties fall into four categories: 

• Light Manufacturing: These places are used for the final assembly of products. They typically include a small amount of storage and/or office space. 

• Heavy Manufacturing: Things are constructed from scratch in these places. Think factories with a large amount of equipment and machinery, and some amount of storage for finished goods while they await shipment. 

• Flex Space: It’s a mix of storage that can easily be converted for various uses. Consider an importer who has a showroom in front of the building and a storage and shipping area in the back. 

• Bulk Warehouse: A bulk warehouse is an enormous distribution space where goods are stored and shipped. Often, they can be up to 1,000,000 square feet and are used by major logistics companies to store and transport goods. Consider an Amazon distribution facility. 

Investors like industrial buildings because they’re always in demand, need a relatively low amount of upkeep, and don’t require an expensive buildout. 

Multifamily

There are two defining characteristics of commercial multifamily apartment buildings. Firstly, they’re places where renters reside, and secondly, they’ve got over four units. Apartment buildings generally fall into four categories: 

• Garden Apartments: These multi-building properties are up to four stories in height. In total, garden-style apartment complexes usually have somewhere in the range of 200-400 units. 

• Mid-Rise: Mid-rise apartment properties usually have 30-100 units, contained within a 5-12 story building. They’re quite popular in downtown cores and usually contain at least one or two elevators. 

• High-Rise: High-rise apartment buildings are over 12 stories and have 100+ units contained within the same building. They’re often found in the central cores of large cities. 

Multifamily properties are preferred by commercial real estate investors because they tend to have relatively stable occupancy, stable cash flow, and have a big institutional demand. These things make it easier to sell. 

Hospitality 

Hospitality properties are mostly hotels, and they’re of three types:

• Full Service: These are hotels that cater to high-end leisure or business travelers. These establishments are usually located in central business districts and offer customers numerous services, such as meals, room service, spa treatments, exercise facilities, and concierge services. Examples include Ritz-Carlton, Marriott, etc. 

• Limited-Service Hotels: These hotels are generally located just outside of business districts or near airports. They’re often geared towards budget-conscious leisure travelers. Instead of a full restaurant, these establishments may have a small lunch counter, or instead of a full gym, they may have a small room with only a few pieces of equipment. Examples include Courtyard by Marriott or Hilton Garden Inn. 

• Extended Stay Hotels: These hotels are geared towards longer-term stays of a week or more. The rooms may have small kitchenettes, may be slightly bigger, or have a sitting area for leisure. Residence Inn by Marriott is an appropriate example. 

Hotels can be surprisingly profitable as an investment, which is why they’re loved by investors. But they’re at the higher end of the risk scale, as they’re subject to high levels of variability and are levered to macroeconomic conditions. 

Mixed-Up Properties 

Mixed-up properties are those that combine more than one use. For instance, one very common type handled by a real estate broker California is an apartment building with ground floor retail space. 

Mixed-up properties are popular with investors because they serve a need in a market, make efficient use of the available space, and offer diverse uses to protect against cyclical economic conditions. 

Land

A piece of land is a vacant property that hasn’t yet been developed for a specific use. Sometimes, the land could be “raw,” which means it doesn’t have any infrastructure, such as power, water, roads, etc. Or, it may be developed with all the necessary infrastructure, including zoning, to offer a turnkey property to developers. 

Real estate investors like land because not much is available these days. The scarcity can be felt in dense urban areas, making them more valuable with time. 

Special Purpose

Finally, special purpose commercial properties are those that don’t generally fall into one of the categories described above. They’ve some sort of unique use or feature that makes them special. For instance, airports or amusement parks could fall into the category of special purpose. 

Investors like special purpose properties because they’re unique and very difficult to replicate, which helps preserve value. 

All these property types have their own property management quirks. Understandably, investors specialize in one or two types to get to know them inside and out. This type of expertise means they can maximize their chance of a profitable outcome. 

The property type is just one consideration for investors looking to gain exposure to a commercial asset. The other major one is to consider the building class. 

CRE Building Classes 

In all the property types described above, there are four building “classes” that can help investors narrow down the type of property they want. The classes are identified by letters from A to D. 

• Class A

Class A properties are the newest, cleanest properties situated at the best spots. They’ve got the best finishes, the most dependable tenants, and the longest leases. They’re also the most expensive. Class A properties are popular among institutional investors seeking stable, dependable cash flow. 

• Class B

Class B properties are solid with a strong tenement base, a good location, and nice finishes. However, they may have some basic deferred maintenance, tenants with expiring leases, or some small amount of vacancy, which is what drives this classification. Class B properties are popular among investors seeking a mix of cash flow stability and potential for appreciation. 

• Class C 

Class C properties have some form of deficiency or another, causing them not to earn top dollar. For instance, they may be situated at an inferior location, or, more likely, the property needs repairs and renovations to bring it up to Class A or B condition. Furthermore, they may have higher-than-market levels of vacancy or major tenants whose lease is about to expire with no guarantee of renewal. These properties are popular among so-called value-add investors who buy the property and invest time and money in repairs, renovations, and negotiations with tenants to renew or extend their commercial leases. 

• Class D 

In most cases, Class D properties aren’t worthy of investing, but they may present a lucrative, high risk, high reward scenario for certain individuals. These properties may have significant structural deficiencies, could be completely vacant, or have a location too far from roads or commercial corridors. Some investors with a vision may be able to make these properties work. 

How to Start Investing in CRE 

If you want to invest in commercial properties, you need to consider four things first: 

• Property Type: Investors must study each property type described above to determine which is the best fit for their individual investment strategy. 

• Property Class: Among the classes described above, investors need to determine which is the best fit for their own investment thesis. 

• Risk Tolerance: Every investor has their own level of comfort with regard to risk. For those who like stable cash flow, it’s better to stick with the types of commercial properties that have triple net leases (NNN) and high-quality single tenants. At the higher end of the risk spectrum, an investor could go for a hotel property in an emerging market. 

• Time Horizon: Some investments, particularly the riskier ones, could take years before they start to deliver a return or may need a long-term commitment before they get their money back. 

Once you determine these items, you can dial in on how you should invest in commercial real estate. 

Ways to Invest 

Based on an investor’s preferences, there are several ways an investor can gain exposure to commercial real estate assets: 

• Direct Purchase: The simplest and most obvious way of buying a property directly is, of course, a direct purchase. The benefit here is that an investor gets full control over the purchase and management process, and they’re the sole beneficiary of the income and profits produced by the property. The problem is that a commercial property is quite expensive and takes time to manage. Handling everything may be too difficult for one person alone. This approach demands time, capital, and expertise. 

• Real Estate Investment Trusts: REIT, or Real Estate Investment Trust, is a special type of company that owns, operates, or finances commercial space (NOTE: Some REITs may work with residential properties). Many REITs are publicly traded, which means that shares in them can be bought and sold in public markets, and they entitle investors to their proportionate share of the income and profits produced by the underlying property. REITs can specialize in specific property types, such as self-storage or retail storefronts. 

The benefit of this approach is that it doesn’t require nearly as much capital to get started, and these shares are fairly liquid. However, the downside is that an investor has no say in the properties their capital is used to purchase. 

• Private Equity Syndications: Another major option is to invest with a private equity firm via the type of syndication structure described above. The benefit of this approach is that an individual investor gets fractional ownership of an institutional quality asset and doesn’t have to spend time managing the property. The issue is that this type of opportunity is only available to Accredited Investors, and fees charged by the private equity firm may cut into profits. 

Among the three, REITs tend to be a good fit for newer investors, non-accredited investors, or those who prioritize liquidity. Syndications tend to be a good fit for high-income earners who want exposure to real estate assets, but not the hassle of managing them. Direct purchases are a good fit for people with significant resources, as well as the time and expertise. 

How Much Do You Need to Begin? 

Well, it depends. 

At the lower end of the spectrum, REIT shares can be bought for less than $100 and can give investors a foothold in the CRE investment space. 

In the middle of the spectrum, private equity syndications usually have a minimum investment requirement somewhere between $50,000 and $100,000. This is a lot of money, but it’s still less than how much you need to make a direct purchase. 

Finally, at the highest end of the range, a direct purchase may require a significant amount of capital, especially if it’s made by one individual. There aren’t any limits, depending on the size of the property being purchased. 

Benefits and Drawbacks of CRE Investing 

Just like any investment, there are both advantages and disadvantages to investing in commercial buildings. The key pros include: 

• Regular income from rental payments. The income may be completely passive in a REIT or a Private Equity Investment. 

• Favorable tax treatment through depreciation and 1031 exchange opportunities. 

• Portfolio diversification beyond stocks and bonds. 

• Tenants with long-term leases and regular rental increases. 

• Good inflation hedge because rents can go up, too. 

These benefits come with certain drawbacks you should be aware of. These include: 

• Private equity and direct purchases can be illiquid, especially when the market is distressed. 

• For direct purchases, the properties can be incredibly time-consuming to manage. 

• Tenants defaulting on their lease terms are an ever-present risk that can reduce the amount of cash flow available for distribution. 

• Fees charged by property managers, asset managers, and brokerage staff can cut into profits. 

• Finally, commercial properties are particularly vulnerable to interest rate changes, which may reduce property values. 

Potential investors should consider the risks and benefits as part of their due diligence process to determine if CRE is a good fit for their own strategy. 

Should You Invest in Commercial Real Estate? 

So, what is commercial real estate? If you’ve been with us since the beginning, you already know the answer. Now, you want to find out whether you should invest in commercial real estate. The short answer is: Yes, it can be profitable. Investors or business owners who’re thinking about allocating capital to a commercial real estate investment should consider their own risk tolerance, time horizon, property preferences, risks, and benefits, and make their own decision about whether it’s the right fit for their own needs. 

FAQs 

Q1. What factors should I consider before choosing a commercial property location? 

A1. Look at foot traffic, nearby businesses, road access, zoning rules, and local demand. A good location supports stable tenants, steady income, and higher long-term property value. 

Q2. How do investors measure whether a commercial property is a good deal? 

A2. Investors check cash flow, expenses, vacancy rates, lease terms, needed repairs, and long-term income potential. These numbers help decide if the property matches their goals and risk comfort. 

Q3. What is the biggest difference between residential and commercial real estate investing? 

A3. Commercial real estate focuses on income from businesses, longer leases, and larger spaces. Residential properties center on individual renters, shorter leases, and daily housing needs. 

Q4. Do interest rate changes affect commercial real estate returns? 

A4. Yes. Higher interest rates increase borrowing costs and lower property values. Lower rates can raise demand, help refinancing, and improve overall returns for many commercial investors. 

Q5. What skills do new investors need before entering commercial real estate? 

A5. New investors need basic financial knowledge, comfort with long-term decisions, understanding of leases, and enough time to study property types and market risks.