In my previous blog post on Property Valuation I mentioned that real estate is subdivided into two main categories: commercial and residential. Today I’m here to help you dig a little deeper into some of the main forms of commercial real estate. Without further ado, let’s go!
Commercial real estate can be subdivided into many different categories depending on who you talk to. I’ve talked to brokers and investors who divide into four, six, eight, ten, or even more categories of commercial real estate. For now I’m going to stick with four of the main categories. These four can subdivide further and there are additional property types but for now, the following four will cover most commercial real estate deals that you will come across.
1. Multifamily - There are both residential and commercial multifamily properties. While all multifamily properties serve a residential purpose, two to four unit multifamily properties are officially considered to be residential properties because they can be purchased with residential financing. Five unit and higher properties are considered commercial multifamily and can only be purchased with commercial financing. While a unit in a 5+ multifamily property serves as a residence for the tenant, the primary purpose of the multifamily property itself is as an investment, whether for a single investor or a group of investors that have pooled their money.
There are many different types of multi-family properties ranging from single structure buildings that have anywhere from five to several hundred units, to sprawling apartment villages that encompass multiple structures with several units in each building. Multifamily properties are generally classified on a letter scale ranging from A class on the very high end, to D class on the very low end.
2. Office - Office buildings are used for business only. As you can probably guess, office buildings are rented or owned by businesses who need a physical office for their business. Like multifamily properties, office buildings vary in size and can range from small single unit offices to high rise buildings with several hundred office spaces. Office buildings are used purely for commercial purposes and so therefore all offices, even those with a single unit, are classified as commercial property and can only be purchased with commercial financing. Office buildings are often purchased by real estate investors who rent the spaces to several different businesses, however sometimes businesses purchase buildings. When a business purchases an office building they will either use the entire space for their own business, or they will use some of the space for their business while renting the other spaces out for extra income. Some businesses are able to completely eliminate their office expense by purchasing a larger office building and renting the additional spaces for enough to cover the building payments.
3. Industrial - Industrial real estate includes assets like manufacturing plants or warehouses. Manufacturing plants tend to require a high degree of customization to fit the needs of the tenant. Most manufacturing activity requires specialized equipment and machinery. The burden of doing renovations can fall on either the building owner or the tenant depending on the contract that is negotiated - always remember - everything in real estate is negotiable. Warehouse space typically requires less customization as it is often used for storage, inventory, and distribution. Because of this, these spaces are often located near freeways, ports, and railroads lines for easy access to transportation.
Industrial spaces are intended for commercial use only and are therefore classified as commercial real estate but in some cities, industrial spaces are converted into several artist studios for people that require large workspaces for projects. Upon conversion, these studios are no longer considered industrial spaces as the purpose of the space has changed from commercial to residential. These studios can be sold packaged together as multifamily buildings for rent, or as individual units that are part of an HOA. This model of conversion is popular in gentrifying areas of densely populated cities like Oakland or San Francisco that have a large stock of unused industrial space and large communities of artists.
4. Retail - Last but not least on our list is retail. Retail real estate encompasses assets like malls and shopping centers. Like office and industrial spaces, retail spaces are intended purely for commercial use and are classified as such. You’ll find a variety of tenants occupying retail spaces ranging from giant chain stores like Walmart to small businesses with only one small location. These tenants can also range from extremely high end luxury boutiques and restaurants to cheap dollar stores. Many malls and shopping centers are owned by investors and individual spaces are rented out to tenants on long term leases.
A common question I receive from investors about investing in retail properties is “What about store closures from online competition?” It’s true that the advent of online shopping and online retailers like Amazon has led to many small retailers going out of business and even many larger retailers having to downsize the number of brick and mortar stores they operate. The trend in all likelihood will continue towards more online and less in person shopping and the coronavirus pandemic has only accelerated this trend. Retail investing has certainly become less desirable and more risky because of this, however we’ve found that retail real estate investor who buy properties that rent to restaurants, small boutiques, and cheap staple goods stores like Family Dollar have seen continued success and healthy profits.