Everything You Need to Know About Commercial Real Estate
Commercial Real Estate (CRE)
According to the wall street journal, commercial real estate sales have bounced back to the pre-pandemic level, thanks to low interest rates. It looks like the future of investing lies in real estate, at least for now. Due to its growth potential, passive income, and consistent returns, it is appealing to the masses.
But what exactly is commercial real estate (CRE) and what are some of the benefits and drawbacks of purchasing or owning CRE? The following topics will help answer those questions and more:
- What Is Commercial Real Estate?
- What Are the Different Types of Commercial Real Estate?
- Advantages and Disadvantages of Commercial Real Estate
- Commercial Lease
- Managing Commercial Properties
- Is Commercial Real Estate a Good Investment Right Now?
- What Are Commercial Real Estate Transactions?
What Is Commercial Real Estate?
Commercial real estate (CRE) is property that is exclusively used to conduct business and provide income at a profit to the property owner. It can either be a building or land as long as they are used for business purposes. Moreover, large residential rental structures also come under commercial properties. These holdings can also bring in rental income as well as investments. They are also financed and taxed in a different manner than that of a residential property.
In short, it is a broad category of assets from stores to shopping malls and office buildings.
What Is the Best State for Commercial Real Estate?
Apart from the mainstays like San Francisco and New York, the best commercial real estate market is St. Louis, Missouri. It set records in the year 2016 by absorbing 6 million sq ft new commercial property. In the next three years, it set record highs for rental rates. The rates peaked in the third quarter of 2019 and remain steady since then.
Their Cortex Innovation District has attracted many a tech giant. Microsoft opened its branch in September 2018.
What Are the Different Types of Commercial Real Estate?
A wide variety of assets fall under commercial real estate. It includes but is not limited to storefronts, land, apartments, and theme parks. Self-storage facilities, industrial properties, government real estate, and marinas also come under CRE.
As such commercial real estate is of 8 types:
They serve as a residency but are built for investment purposes. The property owners make a profit by renting out the residences.
- Duplex, Triplex, and Quadruplex are two, three, and four-unit rental units.
- Garden Apartment is a collection of low-rise apartment buildings, 3-4 stories high. They have a shared yard, no elevators, or access to parking.
- Mid-Rise Apartment is found in urban infill neighborhoods. It is 5-12 stories high with 30-110 units.
- High-Rise Apartment is a residential building more than 12 stories high. They are often managed by professionals.
- Shopping Center is a smaller storefront that sometimes contains anchor tenants like Walmart. It may also be a cluster of small stores in one locality.
- Community Retail Center measures 150,000-350,000 square feet. They contain multiple anchors such as grocery stores, pharmacies, restaurants, etc.
- Regional Mall is a 400,000-2,000,000 square foot large property. It has a handful of department stores, high-end shoppers, and such. They can be indoor and outdoor and are anchored by a major retailer with a handful of smaller stores.
- Out Parcel is a standalone single-tenant asset closer to shopping centers. For example, Starbucks and Panera.
Industrial real estates are one of the best investments due to their flexibility. Moreover, the tenants tend to stay for longer periods due to the difficulty in relocating.
- Heavy Manufacturing is a customized industry space specific to an industry.
- Light Assembly – Product assembly, storage, and workspace
- Flex Warehouse – A combination of workspace and heavy manufacturing
- Bulk Warehouse is a large holding measuring 50,000-1,000,000 square feet. It is used for both storage and distribution.
Much like residential structures, these buildings can also be categorized as low, mid-rise, and high-rise. However, the classification depends on the size, location, and neighborhood.
- A-Class Building – A structure that is best in terms of placement and construction
- B-Class Building – A high-quality construction in a less than desirable area
- C-Class Building – A dilapidated building in a bad neighborhood
- Central Business District – A office building located in the heart of the city
- Suburban Office Buildings – A 80,000 – 400,000 square-feet space located in the suburbs
Hospitality real estate serves people who travel both for pleasure and professional reasons. For example, hotels and temporary-stay residences.
- Full-Service Hotels – Big-name hotels located in central business districts or tourist spots
- Limited Service Hotels – Smaller boutique property with limited amenities
- Extended Stay Hotels are designed for people staying for a longer time period. They have large rooms and a kitchenette.
Mixed-use is a combination of the above-mentioned properties. For example, restaurants or offices with residences on top.
- Agricultural – Undeveloped property used for agriculture, farming, ranch, orchard, and the like
- Infill – A plot within the city, already developed but remains vacant.
- Brownfield – Property previously used for industrial purposes but now available for re-use.
They are other real estates that lie outside the classification but are commercial. For example, Stadium, theatre, zoo, parking lot, bowling alley, and many more.
Advantages and Disadvantages of Commercial Real Estate
Investing in commercial real estate can be attractive to many, especially with the current low interest rates. The stock market behavior has also made this a more viable option. However, as with everything, it has its benefits and drawbacks. Investors need to be aware of both the pros and cons to help make the right choice.
- Steady Passive Income: Commercial property can yield anywhere between 6 to 12% in rent, indicating a steady cash flow.
- Prolonged Tenancy: Tenants with a commercial lease will stay for 3-10 years. It brings about a steady income as long as the tenant occupies the building.
- Capital Appreciation: As long as you maintain the property in a regular manner, it will continue to yield a steady income. Furthermore, the chances are that it will increase in appreciation depending on the market.
- Rules and Regulations: Commercial assets have legalities a mile long. The paperwork, tax, maintenance responsibilities, and legalese often deter buyers from purchasing them. Furthermore, the law and statutes differ according to the state, country, and trade.
- Risk of Tenant Turnover: The uncertainty of the current times has brought a new risk. There has been a slew of unexpected tenant closures without much prior notice.
- Different Needs: With a commercial property, every tenant has a set of specific needs depending on their trade. The cost of renovations can cause you to lose money, especially if you have a high turnover.
A commercial real estate can either be owned outright by the company operating out of it. Or you can also lease it. In the latter case, it is a commercial lease. These leases can run anywhere from 1yr to 10 years. However, the standard time frame is five years and ten years in contrast to the yearly basis of residential buildings. The pricing is run on a yearly basis and is calculated in a price per square foot format.
Data from a 2017 study by the CBRE Group, Inc., a market analyst firm revealed interesting results. They state that the length of the lease is proportionate to the size of the property. This is to lock in reasonable rates in a rising market environment. And also due to the limited availability of properties that match their needs.
Four Types of Commercial Leases
- Single-Net – Tenant is responsible for the property taxes
- Double-Net (NN) – Tenant is responsible for property taxes and insurance
- Triple-Net (NNN) – Tenant is responsible for property taxes, insurance, and maintenance
- Gross – Tenant pays the rent, and the property owner is responsible for the rest.
Managing Commercial Properties
Owning commercial real estate is not an easy task. It requires regular maintenance and ongoing management by the owner. Owners are better off employing a real estate management firm to manage the property and the tenants. They also do general upkeep and oversee the leases. The rules governing these assets vary depending on the state and country. Hence, you need someone knowledgeable to manage your investment.
Is Commercial Real Estate a Good Investment Right Now?
Property, be it residential or corporate, real estate is always worth the investment. Even though few property sectors are in a slump, commercial real estate has been flexible. In fact, the prices have grown at a 1.4% annual rate in 2019-2020. With the US opening up after the COVID-19 lockdown, it should be easier to find CRE right now. The best investments are those ending the financial terms or in troubled waters. You can get those with a discount on the sale as long as you are patient.
What Are Commercial Real Estate Transactions?
The concept of buying a commercial property is referred to as a CRE transaction. The process is similar to that of a residential property but with some slight yet significant changes. A CRE comes with scrutiny from both the buyer, seller, and lender. Unless you are familiar with the intricacies of the law, it’s easy to misstep and get yourself in legal trouble.
What Is Due Diligence in Commercial Real Estate Transactions?
Investing in real estate comes with its risks, both from the buyers’ and sellers’ sides. Due diligence helps to mitigate these risks. It allows you to investigate prospective buyers before buying the property. It encompasses various aspects, including physical and financial conditions. The time between signing the contract and closing is called the due diligence period. It helps you ensure that the cash flow is as mentioned and you are not cheated out of your money.
Any non-residential property used exclusively for business-related purposes is commercial real estate (CRE). These tend to yield a better return than your average residential assets. Instead of renting, they operate within a lease lasting five to ten years, generally on a triple-net.
While real estate in all forms is helpful, CRE has the potential to bring in a significant amount of income. However, it is crucial that you do thorough due diligence before buying the property. Get to know the risks and benefits before investing in CRE.