What is Commercial Real Estate? Common FAQs About CRE
Commercial real estate (CRE) is any property that is used for operating a business. Typically, commercial real estate property is leased out to tenants who use the space to generate income.
CRE is a broad term for a variety of business-oriented spaces in the real estate industry. Properties can range from large business centers with hundreds of units to small, stand-alone storefronts.
Investors, buyers, and renters can find commercial real estate options online or through local property management companies. Because the business and real estate markets are always evolving, commercial real estate is an invaluable part of modern society.
CRE allows individuals and enterprises of all sizes to pursue success and contribute to their communities. Without CRE, many companies would be unequipped to effectively operate or scale, which lends to its importance.
Covered in this article:
- What is Commercial Real Estate? Common FAQs About CRE
- Residential Real Estate and Commercial Real Estate: What’s the Difference?
- What is a Commercial Lease?
- Commercial Lease Structures
- What are the 7 Different Types of Commercial Real Estate?
- Who Owns Commercial Real Estate?
- Who Manages Commercial Properties?
- Benefits of Commercial Real Estate
- Disadvantages of Commercial Real Estate
- Strategies for Investing in Commercial Real Estate
- How to Make Money in CRE
- Best Ways to Get Involved in Commercial Real Estate
Residential Real Estate and Commercial Real Estate: What’s the Difference?
Commercial real estate is different from residential real estate, which consists of property used for living space.
Residential real estate (commonly referred to as “RE” by real estate professionals) refers to properties that are individually owned. This can mean individually owned single-family homes, condo units, townhomes, and land intended for residential development.
When comparing commercial and residential real estate, there are many distinct differences in the overall building structure, design, location, and price range. For example, individuals looking for someplace to call home don’t want to rent out office space — although there are innovative projects today that successfully convert vacant commercial buildings into residential spaces.
There’s also a large difference in how commercial and residential real estate works. First off, each industry requires different real estate licenses. A real estate agent who sells houses operates differently than a commercial agent who manages large business rentals. The two have different clientele, follow different rules and legal regulations, and oversee varying levels of responsibility. Lease agreements for commercial real estate vs residential real estate are also executed differently.
What is a Commercial Lease?
When someone rents a commercial property to run their business, they must sign a lease agreement. A commercial lease explains, in detail, what the tenant is responsible for in order to legally use the space according to the property owner.
Laws for commercial lease agreements vary by state, but most leases cover the same core topics:
- Tenant and owner contact information
- Property details such as address, square footage, and amenities
- Length of the lease term
- Lease renewal obligations
- Cost of rent, utilities, security deposit, and other fees
- Due dates and payment methods
- Terms and conditions for proper usage of the space
- Rules about renovations, tenant improvements, parking, and other important notices
Commercial Lease Structures
There are three types of commercial lease structures to consider: Gross Lease, Net Lease, and Modified Gross Lease. Property owners and landlords establish a lease structure based on the lease type, property type, the tenants’ lease term, and sometimes even the tenant’s business type and intended space usage.
What are the 7 Different Types of Commercial Real Estate?
When pursuing commercial real estate, you’ll notice several primary sectors. Within each sector, there are subtypes, which you can learn in detail below.
Office buildings provide the ideal environment for white-collar and desk job workers. They are comprised of meeting rooms, desk spaces, and common areas. Office spaces can be urban or suburban, low to high-rise properties that suit multiple or single tenants.
There are three classifications of office space. It’s beneficial to know these classifications when getting involved in commercial real estate.
- Class A includes buildings that are newer, more aesthetically pleasing, good quality, have a large selection of top-tier amenities, and are usually positioned in a prime location.
- Class B includes rental spaces that are slightly aged and less aesthetically pleasing. However, Class B buildings are reasonably priced, well-groomed, and excellent options for finding executive suites for lease.
- Class C real estate options include buildings that are the lowest price, often decades old, and typically require some interior or exterior maintenance.
Retail buildings are used by operations focused on sales and merchandise. For example, hair salons, local shops, restaurants, big-box stores, “mom and pop” shops, and grocery stores are all retail commercial spaces. Many retail spaces operate within a leased space.
Industrial buildings support crucial logistical operations for businesses, often allowing open space for large usage of material goods. A few examples of industrial space include warehouses, manufacturing centers, showrooms, storage facilities, distribution centers, and data centers.
Flex spaces have gained popularity for their versatility and adaptability. A flex space, or “flexible space,” is a property that combines warehouse, office, and/or retail spaces to enhance overall business performance.
A common flex space many people are familiar with is a car repair shop. There’s the “floor” where mechanics service customer vehicles, and a designated office space — often in the front of the building — to fulfill transactions. There may also be a showroom where merchandise and repair supplies are displayed for sale.
Another example of flex space is a CPG (consumer packaged goods) business where different areas of the building are divided for specific purposes. The industrial space may consist of a warehouse for production, a storage center for packaging and distribution, and a retail storefront that welcomes in-person shoppers.
While not directly used for business operations, multifamily rental units are considered commercial real estate for the property. Multifamily buildings that are built with the intention to lease individual units, classify the multi-family property as commercial.
For example, large apartment complexes, condominium lots, and even mobile home parks, when leased by the property owner, are classified as commercial real estate. The customers are tenants who inhabit these units, and the business is residential rent and management.
Hotel and Resort Real Estate
Large hospitality businesses comprise the hotel and resort sector of CRE. Common examples include hotels, casinos, inns, resorts, and retreat centers that attract temporary-stay customers. There’s a specific market for hotel and hospitality real estate, as it brings in a continual stream of income without long-term lease agreements.
Storage is a growing sector of CRE. Several types of storage facilities include warehouse storage, container storage, climate-controlled storage (such as heated or refrigerated units), vehicle storage, and 24-hour surveillance storage. Self-storage real estate has low operating costs, relatively high demand, and overall low maintenance.
Who Owns Commercial Real Estate?
Commercial real estate owners are often involved in the real estate industry in more than one regard. An individual or group of individuals typically becomes a CRE owner by investing in a commercial property to make a profit from leasing the available space.
Commercial real estate owners typically uphold one of three roles:
- Property owner or landlord
- A property owner or landlord is the person who owns the asset and is responsible for the property. They must pay the mortgage, set rental prices, pay taxes, cover insurance, and keep organized records of the property. They’re also responsible for finding, screening, and signing agreements with tenants. When it comes to property management, they must handle maintenance, repairs, tenant complaints, and property security or surveillance.
- Investors are professionals who buy properties to then lease the space out and collect a profit. They often delegate property management to employees or third parties. Investors often have multiple investment properties.
- A shareholder owns a portion (or “share”) of a property investment. As the property value goes up, so does their cash flow. Shareholders may also own a company that helps investors make money and then take a portion of dividends, but they aren’t involved in operating the property.
Who Manages Commercial Properties?
If you’re interested in renting or buying a commercial space, it’s important to understand how commercial property management works. Typically, the property owner manages a property themselves — as a landlord — or hires employees to fulfill the different managerial roles. These roles include property manager, building maintenance crew, office manager, and operations staff.
Sometimes, property owners outsource to a third-party property management company. Similar to residential properties that outsource their management operations, using a third-party company means that the maintenance team, leasing office, billing, landscaping, and other aspects of the property are overseen.
Benefits of Commercial Real Estate
One of the primary benefits of commercial real estate is that it can be a lucrative industry with a high demand for more investors and employees. Investing in CRE can be a sustainable, long-term strategy to obtain wealth and be part of the greater good of your local community.
From an investment perspective, CRE has the potential for asset appreciation which can lead to increased cash flow over time There are also major opportunities for tax advantages, capital gains, and passive income.
Additionally, commercial real estate can help investors to diversify their portfolios. Even though volatile markets, CRE investors can seek refuge against income insecurity, as some CRE properties can produce a positive income stream for decades or longer.
Disadvantages of Commercial Real Estate
As with any investment, there are risks and disadvantages to commercial real estate. The biggest risk is the financial one: properties are expensive to buy, manage, and maintain. Managing a commercial property is also a major commitment of time if you can’t afford to outsource to third parties.
Another concern in today’s market is inflation. Rising costs and increased vacancy rates can strain investors as their properties can lose money without paying tenants. There’s also a risk to your credit — ultimately, you can’t control whether or not your tenants pay on time or in full, leaving you to cover the cost of neglected payments.
Lastly — and this is especially important since the challenges presented during the COVID pandemic — CRE comes with some risk to public safety. While you’re not fully responsible for the health and safety of your tenants or their customers, incidents can happen that call for entanglement or litigation. Property owners sometimes face liabilities for risk of injury, health threats, and death of tenants.
Strategies for Investing in Commercial Real Estate
From direct investment to passive investment, CRE is an ambitious way to earn money. One effective strategy for CRE is to invest in a REIT (Real Estate Investment Trust).
REITs are similar to mutual funds where capital from multiple investors is pooled together and paid as dividends. This relieves investors from having to purchase, maintain, or pay fees for properties.
Investing in REIT provides a lower cost to entry in the CRE industry while offering the potential of a steady passive income.
How to Make Money in CRE
To make money in commercial real estate, you must first calculate properties operating expenses against its net income. This is called Net Operating Income (NOI), and it’s an important calculation in any real estate investment. NOI informs you of expected operating costs, and estimates your overall profit. Investors can use this formula to compare different properties and make informed decisions on which property will generate the best earnings.
By utilizing the NOI formula, commercial real estate investors can make smart informed decisions to maximize their earnings potential.
Best Ways to Get Involved in Commercial Real Estate
If you’re considering investing or starting a career in commercial real estate, it’s of great benefit to first get educated. Whether you are purchasing a property or investing in a larger CRE fund, the best way to get started is with the right knowledge, plan, and support.
Set yourself up for success by establishing a clear plan of action before making big decisions. Begin building a professional network of industry experts in your area. If you want to make this a career, many high-level investors begin by working entry-level jobs and then working their way up.
Overall, commercial real estate can be a great way to generate sustainable income and gain capital appreciation.
Finally, remember to stay informed, and invest wisely.
To learn more about commercial real estate, read our free, educational articles all about the CRE industry.
About the author:
Sarah Hoopes is the Marketing Coordinator at Hartman Income REIT. She is a graduate of Utah Valley University with a Bachelor’s degree in Marketing and Business Management.