Commercial Real Estate Explained
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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 is a popular investment strategy because the properties aren’t directly tied to the stock market. On top of that, collecting rent revenues from the properties can be a reliable source of 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.
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 do you invest in commercial real estate?
One of the most popular ways for individuals to invest in commercial real estate is by investing in REITs, or real estate investment trusts. REITs can own, finance, manage or operate real estate. The REIT’s main source of income is the rent it collects from its properties.
Collectively, REITs are estimated to own roughly 500,000 commercial real estate properties in the U.S. that are collectively worth $3.5 trillion. The majority of them are publicly traded companies, so one of the most common ways of investing in commercial real estate is buying shares of a REIT.
Some REITs are privately held companies. Those REITs collect individual investments from their investors, as opposed to having investors buy shares of their company. They don’t have to register with the Securities and Exchange Commission and aren’t regulated by the SEC, either, making them less transparent than a publicly traded REIT.
Most private REITs require a minimum investment that can range between $1,000 and $25,000, but others are designed specifically for high net worth investors and require much higher minimum investments.
Of course, you can also directly invest in commercial real estate by buying a commercial property and leasing it to a business or income-generating tenant. However, this is a riskier investment strategy, because it will almost certainly require you to invest more cash than you would if you simply bought a share of a REIT.
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. And the rise in e-commerce and online shopping has led to more brick-and-mortar retail stores closing their doors for good. On the flip side, e-commerce has also created robust demand for industrial properties to store products along the supply chain.
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.
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.