For investors, commercial real estate can provide a lucrative income, but choosing what type of commercial real estate to invest in is not always easy. There are a number of factors to consider and it’s important to first understand what qualifies as commercial real estate, as well as the different types.
What Is Commercial Real Estate?
Generally, real estate is separated into two categories: commercial and residential. A commercial real estate property is any property with five or more residential units, or a property that is leased to some kind of business. Buildings that qualify as commercial real estate include office spaces, retail spaces, shopping centers, apartment complexes, hotels and industrial spaces.
To put it more broadly, commercial real estate is any property being used expressly for business purposes. Teresha Aird, Co-Founder and CMO at Offices.net, said, “Typically, this relates to buildings that serve as workspaces, manufacturing sites, warehousing facilities, retail destinations or hospitality venues. Multifamily properties, such as apartment buildings, are also considered commercial properties. Profit is often made from commercial real estate through rent generated or capital gains.”
5 Types of Commercial Real Estate: Asset Classes
An asset class is a group of investments with similar characteristics that behave similarly in the market. An asset class is also based on the property’s intended use, said Reid Hogan, a Commercial Real Estate Advisor at MultifamilyCashin.
In commercial real estate, there are several different types of asset classes, which refer to the category of real estate in the commercial market. Those asset classes include retail, office space, industrial space, multifamily buildings and hotel and hospitality properties.
“However, there are a number of commercial properties that fall outside of these asset classes, such as churches and mixed-use developments,” said Aird.
Retail includes properties like standalone stores, malls, restaurants, strip malls and more. Some retail spaces can be multitenant, such as in a strip mall or shopping center where one landlord owns all of the shops. Other spaces might be standalone, single-tenant properties, like a restaurant in its own building, or a pharmacy in an outparcel.
Office buildings are another commercial real estate asset class, and they are usually categorized into urban and suburban properties. Urban office buildings are found in cities and consist of skyscrapers and high-rise properties. Suburban office spaces are smaller, sometimes found in office parks.
Industrial real estate is usually located outside of urban areas, usually along major highways. They are almost always low-rise buildings, categorized into four different types: heavy manufacturing, light assembly, bulk warehouse and flex industrial, and are regulated by light and heavy industrial zoning laws.
Heavy manufacturing buildings are usually customized and built-to-suit with the machinery necessary for the manufacturing of goods and services. Light assembly buildings are not always customized to the tenant, and they are usually used for product assembly and storage. Bulk warehouse buildings are usually large distribution centers. And finally, flex industrial properties are a mix of both industrial and office space.
Multifamily real estate encompasses any residential space with five or more units. This could include apartment buildings, condos, co-ops and townhouses.
5. Hotel and Hospitality
Hotel and hospitality real estate includes any place that provides meals, accommodations and other services for travelers. Hotels could be anything from large chains such as the Hilton or small boutique hotels with only one owner.
Choosing an Asset Class for Commercial Real Estate Investment
There are a number of factors to consider when choosing a type of commercial real estate asset class to invest in.
For starters, “New investors would be wise to factor in current market conditions and emerging trends when looking to dip their toes in the commercial property sector,” said Aird. “For example, the recent pandemic has resulted in significant changes within the office space sector, something which may result in investors being wary of the potential of ‘traditional’ office properties to generate the revenue that they used to.”
For this reason, it’s important to understand what is going on in the market, as well as any external factors that might have an effect on the market before choosing a specific asset class. You don’t want to struggle to find tenants.
“Knowledge of current market factors and demand levels is always advised when investing, and the commercial property sector is no different,” said Aird. Aird recommends investors consider emerging markets, population growth, interest rates, running costs and local infrastructure.
In terms of the specific asset classes, Hogan cited retail and residential properties as the most management-intensive and the most expensive to acquire, with the added factor of having the most tenant turnover. On the other hand, he said, “These units charge the highest rental rates, and small, more affordable properties are sometimes available.”
For office spaces, Hogan said less oversight is required and there is less tenant turnover than with retail and residential assets.
“Small properties such as office condos can be a good starting place for these investors,” said Hogan.
In the industrial space, minimal ongoing management is needed, said Hogan. Although these properties have the lowest rental rates, they are the most stable in terms of occupancy, he added. However, more starting capital is needed for these assets, continued Hogan, as they are quite large.
“Investors should decide whether they will be passive (invest with others) or active (possibly invest alone) investors,” said Hogan. “Either way, they should consider partnering with a veteran for their first investment.”
Commercial Real Estate Makes for a Good Investment
As long as you’ve done your research and fully understand the market, then commercial real estate can make for a great investment. Depending on your own situation, different asset classes might be better or worse for you. If you’re unsure, it’s always a good idea to talk to a veteran investor or a financial advisor who can provide more insight and advice.