What is Commercial Real Estate [CRE]: Definition & Example
Commercial real estate is the golden goose of real estate investing. This trillion-dollar sector is probably the most coveted in the real estate industry as it provides its investors with a steady stream of residual income all year long.
CREs are a great alternative to other branches of real estate, and they provide an excellent ROI to anyone willing to understand the ins and outs. But much to the dismay of newcomers, this sector is often really hard to get a solid grasp on.
I've created this guide especially for newbies in the CRE market who want to have a slice of this trillion-dollar pie. Here, you will learn what commercial real estate is, the types, and how to start investing.
What is Commercial Real Estate?
As the name implies, commercial real estate is a property used or preserved for business-related and commercial purposes. Most times, commercial real estate is rented or leased to tenants for business. Examples include renting an office space or leasing a store for retail purposes. Commercial real estate is also defined as a property that can bring residual income through capital gains or rental income.
Basics of Commercial Real Estate
Commercial real estate is used for industrial or business-related activities. It is different from residential real estate in the sense that commercial properties are not residential structures. They are classified into office spaces, retail stores, buildings for hotels or supermarkets, etc.
A 2017 Nairet report values the United States' commercial real estate at $15 trillion. This boom in commercial real estate can be attributed to the thriving business sector. And as many will admit, many entrepreneurs are setting up start-ups, and many existing retail stores are expanding.
Advantages of Commercial Real Estate
The benefits of commercial real estate continue to attract a lot of people into the industry. An attractive feature of commercial real estate is rent and lease payment.
Commercial property owners enjoy stable rent from tenants. Asides from this, commercial properties are not usually undervalued, and since most of these buildings are known to appreciate, rent in such areas is bound to increase in coming years.
Also, investing in commercial real estate allows equity appreciation. As you grow the equity in your commercial real estate, your asset's value increases, which allows you to leverage and further grow without necessarily putting your investment itself at risk.
Commercial real estate also bears tax advantages. Owning a commercial property allows you to depreciate the asset while writing off all the mortgage interest paid during the year. Also, the national tax laws can be used to favour your commercial real estate investments. For instance, Section 179 of IRS Code allows deductions for equipment and furnishings purchases put into service the same year that they are purchased.
Disadvantages of Commercial Real Estate
There are also downsides to venturing into commercial real estate investment. One problem I have faced as a commercial real estate investor is constant renovations. As a commercial real estate owner, best practices require you to renovate or upgrade the commercial property.
Tenants have varying tastes, and a once and for all renovation may not meet the required satisfaction. Tenants may also have very different needs that require costly refurbishing; the building owner then has to adapt the space to accommodate each tenant's specialized need.
Also, commercial properties are more capital intensive than their residential counterparts. It is usually tricky to acquire a commercial property than a residential one because it requires more capital upfront.
And after you've acquired a commercial property, you should also expect large capital expenditures to follow. This is because owning a commercial property comes with more risks and responsibilities. For instance, if you own a commercial retail building with five tenants, or even just a few, you have more management to do than with a residential investment. You cannot be an absentee landlord and hope to maximize the return on your investment in commercial properties. With commercial real estate, you will deal with multiple leases, more maintenance issues, and public safety concerns.
4 Types of Commercial Property
Various commercial properties serve different purposes. They are grouped into categories for various purposes. These categories include:
Office Space
Office buildings are equipped and created to provide tenants with space for cubicles, conference rooms, a reception area, and the likes. Companies often find it challenging to move their entire workforce around frequently, which is why it is common for office leases to be long-term. Office buildings are classified into three, namely:
Class A: These are often referred to as high-quality office spaces. They have high ceilings, luxurious lobbies, quality management and extensive amenities such as an in-office fitness centre or rooftop. Most high-rise buildings in metropolitan areas are under this category. They are usually expensive to rent.
Class B: Buildings that are in this class are average office buildings. They usually don't have elaborate amenities, but they are still functional facilities with professional management. These types of buildings are located in the suburbs and are older than the Class A buildings.
Class C: This is the lowest tier. These buildings are typically 20+ years and are of the lowest quality in terms of infrastructure. Most Class C buildings are located in undesirable areas, and likely require some degree of repair or renovation.
2. Industrial Use
The industrial sector of commercial real estate includes buildings like warehouses and other types of manufacturing or distribution facilities. They are generally located outside of residential or urban areas and are occupied by a single tenant.
3. Multi-Family Rental
Multi-family buildings refer to properties with multiple units, often referred to as dwellings, usually within one structure. An excellent example of a multi-family property is an apartment building. Multi-family buildings are regarded as commercial instead of residential because they exceed five units, and the landlord intends to earn residual income from rents.
4. Retail
The retail category includes a neighbourhood strip mall or large shopping centres. Typically, retail space is more expensive per square foot than office space, and this is because most businesses that buy or rent this property type are mainly focused on foot traffic. Commercial retail leases are long-term and could range from 5 to 10 years.
How to Invest in Commercial Real Estate
Commercial real estate can be very profitable, and I highly recommend it. Commercial property investors can earn residual income through property appreciation when they sell, but most expected returns are from tenants' rents and leases. Commercial investors can choose to either invest directly or indirectly.
Direct Investment
These kinds of investments require you to become a landlord through the ownership or acquisition of the physical property. A direct commercial property investment means an ownership interest (full or partial) in a real estate asset.
One thing to note is that direct investments require considerable knowledge about the CREs. This is because these properties are often volatile - They offer high rewards but are high-risk investments.
Indirect Investment
Alternatively, Investors can choose to invest in commercial real estate indirectly. You can do this by owning market securities like Real Estate Investment Trusts (REITs) and exchange-traded funds (ETFs). These are investments in commercial property-related stocks or companies that handle the commercial real estate market, such as banks and realtors.
Join a Real Estate Investing Group
The fastest way to increase your knowledge about real estate investing is to learn from people who have been in the game for a significant amount of time. And you can get this from the Everyday Investors Community.
At Everyday Investors, we host free webinars on real estate issues and discuss current real estate trends. Our goal is to help investors get started and make the best return on their money from every development project they embark on. Get more FREE content on how to invest in real estate by joining our community list.
