Commercial real estate refers to a wide range of properties used for business purposes. Commercial properties can make great real estate investments because they typically have a steady market appreciation and long-term leases with stable cash flow.

If you want to get started and be successful, you need to know the different types of commercial properties, the various leases, and how to finance the purchase.

5 Things to Know About Commercial Real Estate

• Commercial real estate (CRE) includes properties used for business activities, such as office buildings, retail spaces, and industrial facilities.
• The U.S. CRE market is valued at approximately $20.7 trillion, offering significant investment opportunities.
• Commercial leases last 3-5 years or more, providing stability through consistent rental income and capital appreciation.
• Types of CRE include multifamily residential, retail, office, and industrial spaces.
• Investment strategies range from direct property purchases to indirect investments through REITs and crowdfunding platforms, catering to different investor needs.

What Is Commercial Real Estate?

Commercial real estate (CRE) refers to properties designed specifically for business activity, including office buildings, retail spaces, and industrial facilities. The commercial real estate market is a massive sector valued at around $22.5 trillion. Typically, these properties are leased to tenants through long-term rental agreements, often lasting between three and five years.

This stability often results in strong returns on investment, driven by both rental income and capital appreciation. Key performance metrics, like net operating income (NOI) and capitalization rates, are essential for evaluating the success of your investments in CRE properties. This makes informed decisions important for maximizing profitability.

Types of Commercial Real Estate

When exploring types of commercial real estate, you'll encounter several key categories, such as retail spaces, office buildings, multifamily, and industrial spaces. Each of these categories caters to specific business needs.

Multifamily Residential

Multifamily residential properties encompass a variety of structures, such as apartment buildings, townhouses, and condominiums, that generate rental income from multiple tenants. In fact, all multi-family homes with five or more units are considered commercial real estate.

Managing multifamily properties can offer economies of scale, leading to lower per-unit operating costs and increased operational efficiencies. The trade-off is that commercial residential investments are more expensive and more complex from a legal and logistical standpoint.

Retail Space

Retail space caters to businesses that sell directly to consumers. These spaces can include shopping centers, strip malls, and standalone stores, each playing a significant role in attracting foot traffic. High-traffic areas are particularly good locations for investments, often leading to higher rents and better sales performance.

Anchor tenants, such as major department stores, typically drive traffic to smaller retail units. The structure of retail leases may involve single-net, double-net, or triple-net arrangements defining tenant and landlord responsibilities. Adapting to e-commerce trends is also important for businesses working to optimize their physical retail spaces.

Industrial Spaces

Industrial properties are used for manufacturing, warehousing, and distribution. These properties are typically situated on large parcels, providing easy access to highways or railroads, which is essential for logistics operations. Functionality is prioritized over aesthetics, requiring basic utilities like power, water, and sewer to support manufacturing facilities. Unique zoning laws may apply, so be sure to ask the right questions before you buy.

Various types exist, including distribution centers and flex spaces that combine office and industrial uses. The industrial real estate sector is marked by lower vacancy rates and longer lease terms, offering stable opportunities for those investing in commercial property.

Offices

Office spaces provide a range of environments for businesses to thrive. They are categorized into Class A, Class B, and Class C.

• Class A properties are high-quality, modern buildings in prime locations
• Class B properties are mid-tier, providing a suitable office space at a reasonable price
• Class C structures may be older and located in a less-desirable area.

Lease terms for these spaces typically range from three to five years, providing stability for both landlords and tenants. Market dynamics, including the rise of remote work, influence the demand for office spaces, which have reshaped how businesses utilize their spaces.

Types of Commercial Leases

When you're considering a commercial lease, it's essential to understand the different types available, as they dictate your financial responsibilities. Below is a breakdown of several types of commercial leases that investors should be aware of.

Single Net Lease

In a single net lease, tenants are responsible for paying property taxes in addition to their rent, while landlords typically handle insurance and maintenance costs. This structure often results in lower base rent compared to gross leases, making it appealing for businesses focused on managing expenses.

Single net leases are commonly found in commercial real estate, particularly in retail spaces and office buildings. With predictable costs for tenants, who only need to budget for property taxes, landlords maintain control over insurance and maintenance, allowing for potential negotiations of favorable terms based on market conditions.

Double Net Lease

In a double net lease, the tenant will pay property taxes and insurance on top of the base rent, while the landlord handles maintenance and repairs. This structure reduces the landlord's financial burden for certain operating costs, making it a popular choice for commercial properties like retail and industrial spaces.

Tenants often gain more control over the property, fostering a sense of ownership and responsibility. Double net leases usually have longer terms, ranging from 5 to 10 years, offering stability for both you and the landlord. This option serves as a middle ground between single and triple net leases.

Triple Net Lease

A Triple Net Lease (NNN) places the majority of financial responsibilities on you as the tenant, requiring them to cover not just the base rent but also property taxes, insurance, and maintenance costs. This lease structure is popular in commercial real estate, especially for single-tenant properties, as it provides stable income streams and predictable cash flow.

While you may benefit from potentially lower rental rates, it's important to be diligent in managing operational costs to avoid unexpected financial burdens. Typically, Triple Net Leases come with longer terms, often ranging from 5 to 10 years, ensuring consistent revenue for landlords while offering you stability in your business location.

Gross Lease

In a gross lease arrangement, the tenant pays a fixed rent amount while the landlord covers all operating expenses, such as property taxes, insurance, and maintenance costs. This structure simplifies budgeting and eliminates unexpected maintenance expenses. For tenants in office spaces, this predictability can be essential for financial planning.

Gross leases can benefit landlords by attracting tenants seeking stable monthly costs, reducing management burdens through consolidated expenses. Full-service gross leases cover all operating costs, while modified gross leases include some shared expenses. This leasing model is particularly popular in urban areas, driven by high demand for commercial real estate.

How to Start Investing in Commercial Real Estate

To start investing in commercial real estate, you'll need to decide between direct and indirect investments. Direct investments involve purchasing properties outright, while indirect investments can be made through Real Estate Investment Trusts (REITs) or crowdfunding platforms.

Direct Investments

Direct investments mean the investor (or team of investors) is directly involved in buying properties, managing commercial tenants, and selling when it's time. To start, you'll need a substantial upfront capital investment, often ranging from hundreds of thousands to millions of dollars, depending on property types and location.

Indirect Investments

Indirect investments in commercial real estate offer a practical way to participate in the market without the complexities of direct property management. You can indirectly invest through real estate investment trusts (REITs), which typically distribute 90% of their profits as dividends, providing a steady income stream.

Crowdfunding platforms also enable you to pool funds for large projects, allowing for lower minimum investments compared to direct ownership. Additionally, exchange-traded funds (ETFs) offer a diversified portfolio of REIT securities, enhancing liquidity and reducing fees.

Pros of Commercial Real Estate Investing

• Strong returns on investment - especially in high-demand areas, with annual yields often surpassing traditional investments
• Longer lease terms - typically prevent tenant turnover, ensuring stable cash flow and predictability
• Portfolio diversification - tends to be less correlated with stock market fluctuations, minimizing overall investment risk
• Consistent income - sectors like healthcare or government properties can offer consistent income even during economic downturns
• Tax benefits - include depreciation and 1031 exchange; can enhance the financial advantages of investments

Cons of Commercial Real Estate Investing

• Higher initial investment - upfront fees and down payments can be a barrier for many
• Lengthy and complex process - may lead to properties not selling as quickly, resulting in lower liquidity
• Economic downturns - may lead to higher vacancy rates, especially in retail sectors
• Tenant turnover process - can be costly and time-consuming, though there are creative ways to fill a vacant space

Frequently Asked Questions

Is Commercial Real Estate Better Than Residential Real Estate?

Commercial real estate can be better than residential because it offers higher income potential and longer lease terms. However, it typically requires more capital upfront, involves higher risks due to market fluctuations, and can have longer vacancy periods. The better option depends on the investor's financial goals, risk tolerance, and market expertise.

Are All Multi-Family Investment Properties Considered Commercial?

In real estate, multi-family properties with four or fewer units (such as duplexes, triplexes, or fourplexes) are classified as residential. Properties with five or more units are considered commercial real estate. This distinction impacts financing, regulations, and valuation methods.

What Type of Commercial Property Is Most Profitable?

Profitability varies significantly between properties. If you're looking to maximize revenue, focus on Class A office buildings in urban areas, retail spaces with strong anchor tenants, or multifamily properties in growing markets. However, any properly researched and managed commercial investment property can be profitable.

Are You Ready For Commercial Real Estate Investments?

Commercial real estate offers a diverse range of investment opportunities, from office buildings to retail spaces. Understanding the types of properties and leases can help you make informed decisions. By carefully assessing your options and conducting thorough research, you can successfully navigate the commercial real estate market and achieve your investment goals.