Should You Invest in Commercial Real Estate?

Commercial real estate is property used for business or investing purposes. Many different property types, including offices buildings, warehouses, retail stores and even laboratories, fit under the broad umbrella of commercial real estate.

Notably, commercial real estate is almost always used to generate revenue for a business, but it can also be a personal investment. Commercial real estate properties aren’t directly tied to the stock market. On top of that, collecting rent revenues from the properties may generate passive income.

What is commercial real estate?

Commercial real estate is any property that can be used to make money, either from being leased to somebody who pays rent, or from being bought and sold as an investment^[0]

You can also think of commercial real estate as any kind of real estate that isn’t used exclusively for lodging, like a single-family home. That said, apartments, also called multifamily properties, are considered to be a kind of commercial real estate.

What are the main types of commercial real estate?

The four main types of commercial real estate are office, multifamily, retail and industrial.

Of course, there are plenty of types of real estate that don’t fit cleanly into one of those categories. There are also mixed-use, special purpose, hospitality space, medical office, laboratory space, land, cold storage, affordable housing, parking garages, manufactured homes, senior living — the list goes on.

Here are definitions of some of those property types:

• Mixed-use refers to commercial real estate that has a mix of uses, such as an apartment complex with a grocery store on the ground floor.

• Special purpose commercial real estate can include a wide swath of property types, including churches, aquariums, movie theaters and other properties that can’t easily be converted for other uses.

• Hospitality refers to hotels and resorts.

• Medical office properties are offices or clinics typically used for outpatient medical purposes.

• Cold storage facilities are large, refrigerated industrial properties commonly used to store things like perishable food and medicine.

• Affordable housing is housing intended for individuals or families who earn less than an area’s median income.

• Manufactured homes are prefabricated, factory-built homes that are also known as mobile homes.

• Assisted living properties are typically residential properties intended for older adults and typically include on-site care providers.

How is commercial real estate valued?

Like all kinds of real estate, much of commercial real estate’s value is determined by its location. Retail properties are going to be more valuable if they’re located in high-traffic areas, for example.

Of course, many other factors play into the value of commercial real estate. Demographic shifts, for example, have led to strong demand for assisted living properties and senior housing as a greater proportion of Americans approach retirement age^[0]

Understanding the value of commercial real estate is anything but simple. That’s why you should work with a broker or expert who understands all the nuances of the property type you’re looking to invest in.

Beyond that, most types of commercial real estate can be sorted into one of three categories — Class A, Class B and Class C — based on their quality, amenities, age, parking ratio, security systems and other factors^[0]

These designations can be somewhat subjective, of course, but they provide both potential tenants and building owners with an idea of what the property does and doesn’t offer.

Class A properties are typically new, well-located properties that offer modern, state-of-the-art amenities. For an office building, that might mean tenants have the ability to control the temperature on their floor; it could also include a rooftop courtyard open to all building occupants. These buildings are often of architectural significance and are as visually appealing as they are practically appealing to potential tenants and owners.

Class B properties won’t be brand new properties, but they’ll typically offer standard amenities and be well-located. A Class B office building, for example, might not offer a rooftop courtyard, but it could include a relatively new cafeteria or tenant lounge. These properties might have been Class A properties when they were built.

Class C properties are older buildings in less-than-idea locations. They don’t offer modern amenities, haven’t been well-maintained or recently renovated, and aren’t visually appealing.

What’s going on in the commercial real estate market?

Real estate prices have a close relationship with interest rates, given that property owners frequently use debt such as mortgages or commercial real estate loans to buy property.

With that in mind, high interest rates have hit the commercial real estate sector hard. In aggregate, U.S. commercial real estate prices have fallen by more than 11% since the Federal Reserve started hiking interest rates in 2022, according to the International Monetary Fund.

What’s more, a lasting shift toward telework and e-commerce has hurt the perceived demand for properties like office spaces and storefronts, creating a situation where commercial property owners face difficulty filling up their properties as interest expenses rise.

More than $1 trillion in commercial real estate debt will come due by the end of 2025, and given the double-whammy of high interest expenses and weak demand, there are serious doubts about whether all of that debt will be repaid.

If the commercial real estate sector is hit by a significant number of defaults, there is some risk that the damage could spread to other parts of the financial system (such as banks that own real estate debt), as it did during the late-2000s housing market meltdown.

Given the current state of the commercial real estate market, investors should think carefully about whether it’s a good idea to buy into it right now. Some speculators may be tempted to bet against commercial real estate at the moment, although that has risks of its own.

However, there are some reasons to be hopeful for a turnaround. The Federal Reserve is expected to cut interest rates at some point in 2024, which could take some pressure off the embattled commercial real estate sector in the form of lower interest expense.

Whether you’re investing in commercial real estate or speculating on a downturn (via short positions or other bearish trades, such as put options), real estate investment trusts (REITs) — publicly-traded companies that own and rent out real estate — are the main way in which investors can get exposure to this segment of the market.

9 best-performing commercial real estate investment trusts as of August 2024

Despite the headwinds facing commercial real estate, some REITs in this segment are still posting positive returns, at least for now.

Below is a list of the nine best-performing nonresidential REITs that trade on major U.S. exchanges, ordered by one-year performance.

Betting against commercial real estate

If you’re worried enough about the commercial real estate market to bet against it, there are several ways to do so. Some REITs can be sold short, and options traders may also be able to buy put options or sell covered calls on them in an effort to profit from a downturn.

However, these are risky maneuvers that may not be suitable for novice investors. Some brokerage accounts restrict short selling to investors who maintain a particular minimum balance, or they may require prospective options traders to fill out a questionnaire assessing their level of familiarity with options.

Even if you meet the requirements to short-sell REITs or bet against them with options, it’s a good idea to be cautious about such advanced techniques.

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