What Is Considered Commercial Real Estate? A Complete Guide to CRE Types
Commercial real estate (CRE) includes properties like office buildings, industrial spaces, retail stores, and multifamily units used for business activities. This guide will explain what is considered commercial real estate and explore the different types.
Key Takeaways
Commercial real estate includes various property types such as office buildings, industrial properties, retail spaces, multifamily units, hospitality properties, special-purpose properties, land, and mixed-use developments, each serving distinct business needs and investment opportunities.
Direct investment in commercial real estate involves purchasing and managing properties, while indirect investment options include Real Estate Investment Trusts (REITs), crowdfunding, and exchange-traded funds (ETFs), offering different levels of control and entry requirements.
Investing in commercial real estate can provide higher returns and predictable rental income, but it also involves higher entry costs, complex management requirements, and exposure to market risks.
Introduction
The distinguishing factor of commercial real estate (CRE) from residential real estate is its central objective of yielding profit through business-oriented activities. By leasing properties to business tenants or reselling for capital appreciation, CRE offers significant income potential. Commercial real estate investors looking to diversify their portfolios can find CRE a viable option, providing steady rental income and potential capital gains.
The objective of this guide is to offer an exhaustive overview of various types of commercial properties, assisting in understanding their distinctive features and potential for investment.
Defining Commercial Real Estate
Commercial real estate (CRE) encompasses any property used for business purposes to generate revenue through capital gain or rental income. It includes a diverse range of properties such as office buildings, industrial spaces, retail stores, and multifamily rentals, all of which contribute to the commercial real estate industry.
Unlike residential properties, which are primarily used for living, CRE properties are designed to support various business activities and are often located in areas that facilitate these operations.
A broad range of assets, including office buildings, residential duplexes, restaurants, and warehouses, are covered under the umbrella of commercial properties. These properties serve diverse business needs and sectors. Additionally, there are hospitality properties, special-purpose properties, land, and mixed-use developments that fall under the CRE umbrella. Commercial properties include buildings or groups of buildings that have five or more residential units, meaning they are defined as such based on the number of units they contain. Understanding these categories is crucial for anyone looking to invest in the commercial real estate market.
Understanding the Major Types of Commercial Properties
Commercial real estate (CRE) covers a wide spectrum of property types, each serving different business needs. The primary categories include:
Office buildings
Industrial properties
Retail spaces
Multifamily units
Hospitality properties
Special-purpose properties
Understanding these categories helps investors identify the best opportunities for their investment goals.
Office buildings, ranging from towering skyscrapers in urban centers to suburban office parks, offer spaces for businesses to operate. Industrial properties support manufacturing, warehousing, and distribution activities, often featuring large spaces with high ceilings and loading docks. Retail spaces cater to consumer goods and services, including shopping centers and standalone stores. Multifamily properties, such as apartment buildings and condos, offer residential units for lease. Hospitality properties include hotels and resorts, while special-purpose properties serve unique needs like medical offices and amusement parks. Each category presents distinct investment opportunities and challenges.
Office Buildings
Office buildings are a prominent category in commercial real estate, providing spaces for corporate and professional enterprises. These buildings can be found in urban or suburban areas, and they are classified into three main categories: Class A, Class B, and Class C. The classification is often subjective and varies by market and location.
The rise of remote and hybrid work has impacted the demand for office space, with some companies re-evaluating their office needs. However, office buildings remain a significant part of the CRE landscape.
Class A Office Buildings
Class A office buildings represent the highest quality in the market, known for their:
state-of-the-art facilities
prime locations
less than 10 years old
high-quality construction
premium amenities
high-end tenant improvements
Located in prime market areas, Class A office buildings attract top-tier tenants and command higher rental rates.
Class B Office Buildings
Class B office buildings are generally older structures, offering functional and decent quality tenant improvements. These buildings are typically well-maintained and located near central business districts, providing a balance of accessibility and cost. While they may lack the premium amenities of Class A buildings, Class B properties cater to a wide range of users and offer rental rates that are average for the market.
Class C Office Buildings
Class C office buildings:
Typically more than 20 years old
Often require significant improvements
Usually situated in less desirable locations
Rented at below-average rates for the area
Despite their lower tier, Class C properties can be attractive to investors looking for redevelopment opportunities to upgrade them to Class B status.
Industrial Properties
Industrial real estate is essential for various industrial operations, including manufacturing, production, assembly, warehousing, and distribution of goods. Industrial properties are categorized into heavy manufacturing, light assembly, bulk warehouse, and flex industrial types. The demand for industrial properties has surged recently due to the increase in e-commerce and direct-to-consumer business models, leading to a growing need for warehousing and distribution centers.
Industrial properties, including industrial buildings, are typically characterized by high ceilings, sturdy floors, and several loading docks to facilitate these operations. They can be used to store goods or operate industrial processes, and they vary greatly in size and function. Urban warehouses or smaller distribution centers in densely populated areas are becoming more popular due to last-mile delivery needs. Understanding these property types can help investors capitalize on the growing demand in the industrial sector.
Light Industrial
Light industrial properties are commonly used for small-scale manufacturing, assembly, and storage. These properties typically do not involve heavy machinery or large-scale production processes and are easier to reconfigure compared to heavy manufacturing buildings.
Light assembly properties are smaller, featuring lighter and more portable equipment, making them versatile for various business needs.
Heavy Manufacturing
Heavy manufacturing facilities involve extensive machinery and large-scale production setups. These properties often contain heavy-duty, customized equipment and require significant renovation when tenants change. Heavy manufacturing buildings require specific zoning regulations due to their environmental impact and may produce significant noise.
Flex Space
Flex spaces are versatile properties that combine industrial activities with office or retail uses. Designed to adapt to various business needs, flex spaces offer a mix of functional areas, making them suitable for companies requiring both office and industrial space within the same property.
Retail Spaces
Retail properties predominantly serve as spaces for marketing and selling consumer products and services to the public. These spaces are designed to attract and accommodate customers in order to drive sales. They can be classified into multi-tenant structures like shopping centers or single-use standalone buildings. The retail sector includes a wide range of commercial spaces, from big box retailers to mom-and-pop convenience stores, as well as retail and office spaces. However, the rise of e-commerce has led to a reduction in demand for traditional brick-and-mortar retail spaces.
Retail spaces are increasingly being converted into mixed-use developments to offer unique in-person experiences. Retail tenants have a vested interest in maintaining their storefronts, aligning their interests with property owners. Understanding the different types of retail properties and their evolving landscape is crucial for investors looking to capitalize on this sector.
Shopping Centers
Shopping centers often feature major national department stores as anchor tenants, drawing significant foot traffic that benefits smaller retail businesses within the complex. Lifestyle centers, a type of shopping center, prioritize open-air layouts and can include a mix of retail, dining, and entertainment options.
Shopping centers are adapting to e-commerce by incorporating entertainment and dining options to attract physical visitors.
Standalone Stores
Standalone stores are single-tenant retail buildings that face increased pressure to offer unique and personalized shopping experiences to compete with online retail. To adapt to e-commerce trends, these stores are often being repurposed or downsized to reduce overhead costs. Despite these challenges, standalone stores can provide distinct advantages such as strong brand presence and dedicated customer base.
Mixed-Use Retail
Mixed-use retail spaces often have retail on the ground floor with apartments or offices on the floors above. These developments are designed to encourage foot traffic by offering a variety of amenities in one location. Mixed-use retail properties mitigate risks associated with single-use spaces, providing a balanced mix of residential, commercial, and retail uses.
Multifamily Properties
Properties with five or more residential units, termed as multifamily properties, fall under the category of commercial real estate. This category includes apartment buildings, condominiums, and townhomes. Multifamily properties, as a form of residential property, provide residential units for lease, making them a popular investment choice for generating rental income.
These properties often qualify for residential loans, which typically offer lower interest rates and longer repayment terms compared to commercial loans.
Apartment Buildings
Apartment buildings are residential units owned by a single property owner and often require professional property management. Due to their larger scale, apartment buildings typically fall under the commercial classification when they contain five or more units.
These properties can offer significant rental income and are a staple in the multifamily sector.
Condominiums
Condominiums are individually owned units within a larger building, with owners holding a share of common areas and often overseen by homeowners’ associations (HOAs). HOAs manage the maintenance of shared spaces and amenities, ensuring the property remains in good condition and providing a community-like environment for residents.
Townhomes
Townhomes are multi-story homes that share one or two walls with adjacent properties, typically featuring individual ownership of the units. They often include small private yards or patios, distinguishing them from other types of multifamily properties.
Townhomes blend the benefits of single-family homes with the convenience of shared community amenities.
Hospitality Properties
Hospitality properties include:
Hotels
Motels
Resorts
Bed & breakfast establishments
These properties cater to various market segments such as luxury, midscale, and economy, targeting business travelers, tourists, or long-term guests.
The hospitality sector provides accommodations, meals, and other services, making it a dynamic and diverse category in commercial real estate.
Limited-Service Hotels
Limited-service hotels typically do not offer services like room service or on-site restaurants. They may provide basic amenities such as daily housekeeping and complimentary breakfast. These hotels focus on providing essential services at lower costs, appealing to budget-conscious travelers.
Full-Service Hotels
Full-service hotels cater to both business travelers and vacationers, offering amenities such as pools, fitness rooms, and multiple dining options including restaurants and room service. They often have extensive meeting and event spaces for conferences and social functions, contributing to higher service levels and guest satisfaction.
Extended Stay Hotels
Extended stay hotels are designed to provide a home-like environment for guests staying for a week or longer. These properties often include kitchenettes and living areas in guest rooms, making them suitable for long-term stays. Guests benefit from amenities like in-room kitchens and on-site laundry facilities, often at discounted rates for extended stays.
Special Purpose Properties
Special purpose properties refer to buildings specifically designed for certain activities or demographics. Examples include medical office buildings, self-storage units, and amusement parks. These properties are designed with unique specifications to support their specific functions, such as advanced HVAC systems in medical offices or extensive safety measures in amusement parks.
Investing in special purpose properties can be advantageous due to their unique market niches and potential for stable demand. Some examples of special purpose properties include:
Self-storage units, which have seen a significant increase in demand due to their low operating expenses and minimal upkeep
Hotels and resorts, which cater to tourists and travelers
Medical facilities, such as hospitals and clinics
Educational institutions, including schools and universities
Understanding the characteristics and market dynamics of special purpose properties can help investors make informed decisions in this specialized sector.
Medical Office Buildings
Medical office buildings are designed to cater specifically to healthcare services, providing spaces for doctors’ offices, outpatient clinics, and specialized medical services. These buildings often include patient waiting areas, examination rooms, and specialized systems to ensure efficient healthcare delivery.
Key features such as ample parking, easy accessibility, and on-site pharmacies enhance their functionality.
Self-Storage Units
Self-storage units offer flexible storage solutions and are utilized by one out of every ten people in the U.S., contributing to their steady demand and reliable investment potential. Investment in self-storage construction has skyrocketed due to their low operating expenses and minimal upkeep.
These facilities often include more than 30% office space, making them versatile and resilient to economic downturns.
Amusement Parks
Amusement parks are special-purpose properties designed for entertainment and recreational activities. These properties require significant investment in maintenance, safety, and operational staff to ensure a quality visitor experience. Amusement parks feature rides, games, and other attractions, catering to the public and providing a unique investment opportunity.
Land
In the realm of commercial real estate, land can be classified as:
Greenfield Land: Undeveloped agricultural land that has never been built upon or developed.
Brownfield Land: Land that has been previously developed but is now vacant or underutilized. It may require environmental remediation before redevelopment.
Infill Land: Land located within an already developed area, often in urban or suburban settings.
Undeveloped land, or raw land, represents parcels that have not been built upon or developed. This land category is pivotal for future development projects and can generate profit similar to buildings that house businesses. However, land investment also carries risks and requires careful assessment of zoning, environmental studies, accessibility, and grading.
Greenfield land is typically found in rural or suburban areas and offers a blank canvas for development. Brownfield land, on the other hand, involves previously used parcels that may require environmental cleanup due to contamination. Infill land is located within existing urban areas, facilitating more efficient use of space and reducing urban sprawl. Each type of land presents unique opportunities and challenges for investors.
Greenfield Land
Greenfield land refers to undeveloped sites located in rural or suburban regions. These sites offer a blank canvas for development, allowing for flexible and extensive planning. Projects on greenfield land typically involve starting construction from scratch, providing opportunities for innovative and large-scale developments.
Brownfield Land
Brownfield land involves previously used parcels that may be contaminated and require environmental cleanup. These sites often require significant cleanup due to previous industrial uses, which can include:
the removal of hazardous substances
soil remediation
groundwater treatment
demolition of existing structures
Despite these challenges, brownfield sites can be advantageous as they are typically located in urban areas with existing infrastructure.
Infill Land
Infill land involves underused or vacant parcels within an existing urban area, facilitating more efficient use of space. Developing infill land can help reduce urban sprawl by utilizing already developed areas.
These projects aim to maximize the use of urbanized areas, contributing to sustainable and smart city growth.
Mixed-Use Developments
Mixed-use developments merge multiple functionalities within a single building or site, amalgamating residential, office, and retail spaces to foster vibrant community hubs. These developments reduce transportation needs by integrating living, working, and shopping spaces in close proximity. Mixed-use developments are favored by investors and communities because they cater to a broader consumer base and can offer better financial returns.
Vacant retail spaces are increasingly being repurposed for non-retail uses like offices and healthcare facilities. Urban mixed-use developments often feature high-rise buildings combining residential and commercial uses, while suburban mixed-use centers blend residential and commercial spaces in less densely populated areas. These projects enhance local amenities and services, creating dynamic and sustainable communities.
Urban Mixed-Use
Urban mixed-use developments often integrate:
Residential, commercial, and recreational spaces within a single project
Properties located in central city areas
High-rise buildings combining residential, commercial, and sometimes industrial uses
Infill or urban renewal strategies, upgrading buildings and public amenities in city centers
Suburban Mixed-Use
Suburban mixed-use developments are generally located in less densely populated areas compared to urban mixed-use projects and combine residential and commercial spaces. These centers are often built from the ground up and include retail, apartments, and office spaces. Suburban mixed-use projects enhance local amenities and services, creating a new or more prominent ‘downtown’ for suburban communities.
Vertical Mixed-Use
Vertical mixed-use buildings stack different uses, such as residential, office, and retail spaces, within a single high-rise structure. These properties integrate different types of spaces on each floor, maximizing limited urban space.
Vertical mixed-use developments offer a practical solution for densely populated areas, providing a mix of functions in one building.
Direct vs. Indirect Investment in Commercial Real Estate
There are two ways to invest in commercial real estate - directly or indirectly. Direct investment involves purchasing and managing a property yourself, offering greater control over investment decisions. This method allows investors to select properties based on specific criteria and manage them according to their unique knowledge. However, direct investment also comes with the responsibilities of managing and maintaining the property, which can be time-consuming and complex.
Indirect investment, on the other hand, involves methods such as Real Estate Investment Trusts (REITs), crowdfunding, and exchange-traded funds (ETFs). This approach provides ease of entry and diversification, allowing investors to participate in commercial real estate without the need for direct ownership. While indirect investment means less control over specific assets, it offers a way to invest in CRE with lower initial capital and reduced management responsibilities.
Direct Investment
Direct investment in commercial real estate involves purchasing a property and managing it or hiring a property manager. This approach allows for targeted investment decisions based on specific or unique knowledge. Property owners might employ a commercial real estate management firm to handle tenant management, leases, and property upkeep.
REITs
Real Estate Investment Trusts (REITs) are publicly traded companies that own and manage portfolios of properties, leasing them out and distributing profits to investors as dividends. Investing in REITs provides a way to invest in commercial real estate without directly owning properties.
Publicly-traded REITs offer easier buying and selling of shares compared to direct investing.
Crowdfunding
Commercial real estate crowdfunding allows groups of individuals to collectively fund large projects with lower initial investment requirements. Crowdfunding platforms enable multiple investors to pool their funds, making direct commercial real estate accessible to a broader range of investors. This method allows participation in larger projects and offers diversification opportunities.
Pros and Cons of Commercial Real Estate Investment
Investing in commercial real estate has both its pros and cons. On the plus side, CRE investments can provide stable cash flow and high returns, making them attractive to investors. The income generated from commercial properties is often more predictable and stable, especially with professional tenants.
However, there are also significant challenges, including high entry costs, complex management requirements, and market risks. Understanding the pros and cons helps investors make informed decisions about their commercial real estate investments.
Pros
One of the main advantages of investing in commercial real estate is the potential for higher returns compared to residential properties. Commercial properties often have an annual return off the purchase price between 6% and 12%, which is higher than returns from single-family home properties.
Additionally, CRE investments typically involve more stable and predictable rental income due to professional relationships with tenants.
Cons
A significant disadvantage of commercial real estate investment is the higher complexity and greater amount of capital required compared to residential real estate. Acquiring commercial property generally demands more capital upfront and involves potential large capital expenditures.
Managing commercial properties also requires a significant time commitment due to the need for handling multiple leases and maintenance issues.
Summary
Commercial real estate offers diverse investment opportunities across various property types, each with unique characteristics and potential benefits. From office buildings and industrial properties to retail spaces and multifamily units, understanding the nuances of each category is crucial for informed investment decisions. While CRE investments can provide substantial returns and stable income, they also come with challenges such as high entry costs and complex management requirements. By weighing the pros and cons, investors can navigate the commercial real estate market with confidence and potentially achieve significant financial gains.
