Commercial real estate is property that is typically leased out for business and retail purposes. Investing in commercial real estate involves the purchase or development of properties that have been designed with the intent of housing commercial tenants. Unlike a residential real estate investor, commercial real estate investors lease out and collect rent from the businesses that occupy space in their properties, rather than from residential tenants. It should also be noted that raw land purchased for the development of commercial property is also included in this definition. Commercial properties can generally be categorized into five main types. Keep reading to learn more about each one.
The 5 Types Of Commercial Real Estate
Before we get into the mechanics of how to invest in commercial real estate, it’s important to understand the various types of commercial properties. This way, you can start thinking about the commercial asset type in which you want to specialize. Commercial properties serve a broad range of purposes, but are generally grouped into the following types:
- Special Purpose
The most common commercial real estate type is office space. These buildings, which can range from single-tenant offices to skyscrapers, are defined by one of three categories: Class A, Class B, or Class C.
- Class A commercial real estate properties are typically newly built or extensively renovated buildings located in excellent areas with easy access to major amenities. They are typically managed by professional real estate management companies.
- Class B commercial real estate properties are often older buildings that require some type of capital investment. Although they are well-maintained and managed, these properties require minor repairs and upgrades—making them a popular target for investors.
- Class C commercial real estate properties are typically used for redevelopment opportunities. They are generally poorly located, require some type of major capital investments to improve out-of-date infrastructure, and their high vacancy rates are much higher than higher-classed buildings.
Another popular commercial real estate type is retail buildings. These properties, which range from strip malls and community retail centers to banks and restaurants, are often located in urban areas. The size of these real estate properties can extend anywhere from 5,000 square feet to 350,000 square feet.
From warehouses to large manufacturing sites, industrial buildings are typically geared towards manufacturing industries, as they offer spaces with height specifications and docking availability. In addition, these commercial properties generally lend themselves more to investment opportunities.
Multifamily properties are comprised of apartment complexes, high-rise condominium units and smaller multifamily units. A property is qualified as multifamily real estate any time it has more than one unit, but can also be considered a commercial property if it has more than four units. Many residential investors get their start in commercial properties by expanding into larger multifamily properties. Residential tenants tend to have shorter lease terms than office and retail tenants, so tenant turnover is a factor that should be considered.
5. Special Purpose
In general, special purpose properties are designed for a specific use, so much so that it would be difficult to repurpose the property for another use. Car washes, self-storage facilities and schools are all examples of special purpose properties. The leisure and tourism industries represent a large proportion of special purpose real estate as well. Common examples within the industry include hotels, airports and sports stadiums, and amusement parks.
Mixed-use development properties are also prevalent in the commercial real estate sector, and continue to grow in demand. These properties represent a mix of different uses, such as residential, retail and even public sector. A mixed-use building could have shopping and services on the first floor with apartment units on the upper floors, for example.
The Many Benefits Of Commercial Real Estate Investing
Investing in commercial real estate can be very rewarding, both personally and financially. For many, the objective of investing in commercial real estate is for future wealth and security; others utilize it for tax benefits and investment portfolio diversification.
A commercial redeveloper can also take advantage of the following benefits:
- Higher Income: The hallmark benefit of investing in commercial real estate is a higher potential income. Generally speaking, commercial properties have a better return on investment, an average of six to twelve percent, while single-family properties fetch between one and four percent. Secondly, commercial real estate provides a lower vacancy risk, as properties tend to have more available units. (Consider this: one vacancy in an office building with 25 commercial spaces will negatively impact an investor’s bottom line more than one vacancy in a residential duplex.) In addition, commercial leases are generally longer than those you will find in residential real estate. This means that, commercial real estate owners have to deal with far less tenant turnover.
- Cash Flow: Commercial real estate has one very distinct advantage: a relatively consistent stream of income due to longer lease periods. In addition, commercial properties often have more units than residential properties, which means you can achieve economies of scale and multiply your income streams much more quickly. Known in the industry as a triple net lease, many commercial tenants also pay the building’s real estate taxes, property insurance and maintenance costs, thus increasing your owner benefits.
- Less Competition: Another advantage associated with commercial real estate is relatively less competition. Because of the perceived difficulty of commercial investing, the commercial space tends to be less saturated with other investors.
- Longer Leases: Perhaps one of the biggest perks of commercial real estate is the attractive leasing contracts. Commercial buildings generally have longer lease agreements with tenants compared to residential properties, which, as previously stated, offers investors impressive returns and significant monthly cash flow. In many cases, lease agreements for commercial properties are signed for multiple years.
Commercial real estate investing offers investors an array of opportunities and advantages that other investment strategies do not. Once the benefits of commercial real estate investing are recognized, the next step is dive in. Read the following to receive tips on how to get started in commercial real estate.