There are several fantastic investing possibilities in commercial real estate (CRE). Commercial real estate, however, is also very broad. You can decide to invest in a range of various property kinds based on your financial goals and particular circumstances. As a result, to make wise investment choices, investors should first have a firm grasp of the many categories of commercial real estate.
We’ll examine an overview, benefits, and drawbacks of the six main forms of commercial real estate in the article that follows. We’ll discuss the following subjects in further detail:
- CRE Type 1: Apartments / Multi-family
- CRE Type 2: Industrial Space
- CRE Type 3: Office Space
- CRE Type 4: Retail
- CRE Type 5: Hospitality
- CRE Type 6: Medical
- Final Thoughts
CRE Type 1: Apartments / Multi-family
Overview
Multi-family residences with several separate units are, in general, considered to be multi-family commercial real estate. Multi-family properties include two- to four-plexes in a technical sense. On the other hand, from a financial standpoint, lenders typically classify these sorts as residential real estate.
Apartment buildings of five units or more, however, are regarded as commercial real estate. Investors typically use commercial credit while debt financing significant projects as a consequence. The following are a few of the most popular pieces for multi-family dwellings, however, they are by no means all-inclusive:
- Garden-style condominiums
- Mid-rise condominiums
- high-rise residences
- Student residences or dormitories
- Assisted living and senior housing
Investment Benefits and Drawbacks
Multifamily residences have a lot to offer, including familiarity. Even those who have never owned an apartment building have probably lived there at some point. The relationship between the landlord and renter is therefore naturally familiar. As a result, apartment owners may provide greater assistance for their renters since they are more likely to grasp the requirements and basic characteristics of a tenant.
Apartments also outperform several other commercial property categories in terms of cash flow. While losing just one industrial tenant might destroy a homeowner’s revenue flow, multi-family real estate is not all or nothing. The revenue from the other apartments helps cover these openings when you drop a couple of residential renters. For instance, 2 vacancies in a 50-unit apartment complex won’t likely prohibit you from paying your monthly mortgage.
However, the biggest drawback of this kind of commercial property—high turnover—is closely related to this benefit of residential buildings. Tenants move in and out of apartments regularly since many of them offer month-to-month or annual leases. These rotations incur direct labor and upkeep expenditures in addition to costs associated with vacancies. When a tenant vacates, the landowner (or management firm) is responsible for cleaning, painting, and marketing the flat to find a new renter. The expenditures associated with turnover can account for a sizable amount of a building’s operational expenses.
Type 2 CRE: Industrial Space
Overview
The location, size, and usage of industrial space vary greatly in comparison to multi-family homes, which have a single purpose (i.e., as homes). This property type may have a bulk storage warehouse close to a port facility depending on the requirements of a certain tenant. Alternately, a large-scale production plant close to certain natural resources can be needed by a heavy manufacturer.
In summary, there is far greater diversity in the field of industrial property, with the following broad categories:
- Heavy manufacturing
- Light production/assembly facilities
- bulk warehouses
- Flexible commercial space (part office, part industrial)
- warehouses with refrigeration and cold storage
- Showrooms (hybrid office, warehouse, and retail)
- Storage areas
Investment Benefits and Drawbacks
Industrial renters are very dependable since they frequently stay somewhere for a very long period. Simply said, once a tenant establishes operations in an industrial facility, there is typically little motivation to transfer because of how specifically designed the buildout is for that particular tenant. This generates steady, long-term income flows from rentals for investors.
In terms of macroeconomic changes, COVID-19 has also boosted the expansion of online commerce and the related logistics of delivery. This indicates that Amazon and affiliated businesses will keep growing their bulk storage and fulfillment facilities, including both large-scale hubs and smaller, micro-logistics facilities in and near residential areas. Because of the increased need for these facilities, there will be more prospects for industrial facilities to attract investors.
However, the distinctiveness of the majority of industrial spaces also acts as a built-in disadvantage to this property category. Even while renters often stay in one spot for a long period, the buildout necessary to install a specific tenant can be costly and time-consuming. Because one tenant’s interior layout may not suit the requirements of another, switching renters might be difficult. Notably, landlords can lessen this effort by including tenant allowances in the lease and requiring that the tenant bear the majority of the burden of the buildout.
Type 3 of CRE: Office Space
Overview
The commercial real estate geared at white-collar firms is included in office space, as the name implies. Regardless of the specific architecture, an office typically functions the same way. Due to this, investors divide office properties into three categories: age, condition, and location, as opposed to subdividing this property type according to function. To be more specific, investors evaluate office buildings using the following classifications: Class A (newest, highest-quality, best location), Class B (mid-range), and Class C. (oldest, in need of repairs, less desirable location).
Office structures may be found mostly in the following places:
- Properties in the Central Business District (CBD)
- residences in commercial zones
- urban office structures
Investment Benefits and Drawbacks
Office buildings typically have several tenants, much like multi-family homes do. This gives this sort of commercial real estate a significant advantage since it prevents the landlord from suffering a significant cash flow loss if one tenant leaves an office.
However, the success of office buildings very closely mirrors the state of the overall economy. Office property investments do well when the economy is doing well and occupancy rates stay high. In contrast, during a recession (or epidemic), office buildings, notably Class B and Class C, suffer.
Type 4 CRE: Retail
Overview
Any property intended for tenants who conduct direct sales of goods or services to consumers is considered a retail property. The majority of retail establishments are also situated in places that enhance customer convenience as a result of this business-consumer contact.
Depending on the tenant and their particular area of expertise, retail spaces can come in a broad range of sizes and layouts, much like industrial buildings. The following are the main retail sub-categories:
- Community shopping malls
- standalone / out parcel shops (e.g. a chain restaurant located in a mall parking lot)
- Power and anchoring hub (anchored by a major regional retailer)
- Local malls
- Neighborhood retail complexes and strip malls
Investment Benefits and Drawbacks
Now let us begin with the “elephant in the room” of retail: the destruction that online shopping has brought upon many brick & mortar establishments. Despite the fact that this is the case, many businesses that provide services cannot go online (e.g. nail salons, gyms, beauty parlors, etc.). Even while some sorts of retail might no longer make sense from a commercial real estate perspective, the property is still conceivable.
In addition, a lot of retail locations are leased on a “triple-net” basis, which means that the tenants manage all maintenance and other costs associated with the property. This offers a terrific way for investors to generate passive income. After installing one of these renters, you mostly only have to relax and collect rent.
Type 5 CRE – Hospitality
Overview
The demands of passengers are the main beneficiaries of hospitality real estate. This can apply to tourists as well as business travelers. These types of facilities include anything from little bed & breakfasts to enormous hotels and everything in between. Important hospitality sub-categories include:
- Cheap hotels
- Long-term/extended-stay hotels
- Integrated hotels
- hotels with limited services
- properties designed with short-term rentals in mind (e.g. Airbnb or VRBO)
Investment Benefits and Drawbacks
To a greater or lesser extent than office space, hospitality buildings frequently reflect the general economy. This characteristic has both advantages and disadvantages for investors by nature. When combined with the emergence of internet services like AirBnB and others that more efficiently connect people with hotel options, hospitality investments may provide enormous profits in economies with robust demand. However, investments in hospitality assets perform poorly when the economy falters or, as we’ve just seen, health difficulties limit travel.
Type 6 CRE: Medical
Overview
We’ll talk about medical properties as a subset of commercial real estate last. Although some investors group these properties under a more general retail heading, their special qualities call for a distinct consideration.
Even though there are several subcategories, all medical characteristics serve the same function: to meet the demands of the medical industry. To that aim, typical kinds consist of:
- nearby dental and medical offices
- Centers for in- and out-patient surgery
- Acute care facilities
- nearby hospitals
- significant regional hospitals
Investment Benefits and Drawbacks
Purchasing medical real estate might be an excellent counter-cyclical hedge for your portfolio. In other words, individuals require medical care regardless of their financial situation. As a result, whereas office buildings and retail establishments may struggle during a downturn, medical assets often do well.
Likewise, medical tenants need exceedingly expensive and custom buildouts, much like industrial renters do (e.g. lead-lined walls, wide-access elevators, enhanced plumbing systems, etc.). Because of this, a medical tenant will probably use a space for a considerable amount of time. Simply said, it takes too much effort to move.
Building medical buildings need incredibly specific expertise and experience from an investment standpoint. Medical assets are an exceptional class of commercial real estate, nevertheless, for those wishing to participate as limited partners or other capital contributors since they provide steady and high returns. Finding one of these bargains will probably be the biggest problem you have.
Final Thoughts
Commercial real estate investments may yield extraordinary profits. Investors must, however, be well-versed in the many categories of commercial real estate before jumping into a purchase. With the high-level reviews mentioned above as a guide, novice investors may narrow their plans and choose the sort of property that will best serve their goals.
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