Commercial Real Estate Definition And 4 Types

You must know by now what real estate is. Real estate is basically land, real property, and any improvements to the land. 

Commercial real estate is one of the four types of real estate, which are 

• Residential Real Estate.
• Commercial Real Estate.
• Industrial Real Estate.
• Land.

A successful investor in commercial real estate has the potential for a highly successful career. 

Most investors might want to engage in any type of commercial property, but it’s necessary to have a very good business plan before venturing into commercial real estate. 

In this article, we will discuss all you need to know about commercial real estate for beginners. 

What Is Commercial Real Estate?

Commercial real estate is defined as property used solely for business-related purposes or to provide a work area rather than living space. 

Purchasing or developing real estate that has been planned to house commercial tenants is also a component of investing in commercial real estate. 

If real estate makes money for you, is for investment, is rented, or is not used as a private residence, it is considered commercial real estate.

Let’s learn the types of commercial real estate

Types of Commercial Real Estate (CRE)

These typical commercial real estate types you see every day will help you understand the various CRE types. 

1. Retail Space 

This is another type of commercial property. They include retail centers, shopping centers, or malls and are at the center of most towns and cities.  ​​

Here, individuals come to shop, eat, and meet with friends. Due to the fact that many retail buildings are leased out on long-term triple net leases, where the tenants cover all costs, most investors choose retail space to invest in. 

2. Office Building 

This type of commercial real estate is the most common type of real estate. It includes office spaces, reception areas, cubicles, and even warehouses. 

Leases Used in Commercial Office Buildings 

There are different types of leases used in commercial office buildings. They include

• Full-service lease: This is also called a gross lease. In this lease, the tenant pays for rent alone, and the landowner pays for insurance, taxes, and maintenance. 
• Double Net (NN) Lease: Here the tenant is responsible for paying insurance and taxes, but the landowner pays for maintenance.
• Triple Net (NN) Lease: In this type of lease, the tenant pays you rent plus taxes, insurance, and maintenance. This type of lease is most exciting for investors. 
• Single Net Lease: The tenant is responsible for paying only taxes, excluding insurance and maintenance.

3. Industrial Properties 

Warehouses, business apartments, distribution hubs, and manufacturing facilities are all examples of industrial properties. 

Industrial Properties can range in size and use. A quality industrial properties investment will have the following 

• Be in close proximity to transportation facilities
• Have few or no constraints on how much water is used.
• Located close to grocery stores and other facilities in urban areas
• Be clean, safe, and equipped with a kitchen, bathrooms, and air conditioning. 

4. Multi-Family Real Estate 

For new real estate investors, multi-family real estate might be a great way to begin purchasing properties that can produce passive income.  

This implies investing in more than one rentable space, unlike single-family real estate, which involves having only one unit available for rent. 

They are available in various shapes and sizes, including  

• Retirement Homes
• Duplexes
• Triplexes
• Apartments
• Mixed-used properties (residential and commercial use)

Special Purpose Properties 

This is a kind of real estate designed with a specific purpose in mind. Gas stations, restaurants, car washes, and schools are good examples of special-purpose real estate. 

As an investor, important things to watch out for are interest rates, company confidence in that particular industry, and the overall health of the economy.

What You Need To Get Started In Commercial Real Estate

Desire 

To achieve anything in real estate, all you need is a strong desire. Your desire will determine if you will succeed in real estate or not.

A Calculator 

It might sound funny, but a simple calculator isn’t bad for an investor. Nothing special is required.

A Cell Phone 

With a cell phone, you can call any real estate agent, property manager, or seller and even set up appointments. 

Three hours a week of dedication to the work will be beneficial to you. You’ll achieve your goals more quickly if you put in more time working toward them. 

Benefits of Investing in Commercial Real Estate

Commercial real estate investing has the potential to be incredibly lucrative on both a personal and financial level. 

A common reason for investing in commercial real estate is to increase one’s wealth and security; however, additional reasons include tax advantages and the diversification of one’s investment portfolio. 

Here are the benefits of investing in commercial real estate

1. Higher Income Generation 

A higher potential income is the defining advantage of investing in commercial real estate. In fact, commercial property’s annual return on investment normally ranges between 6% and 12%. 

Unlike single-family property, which averages between 1% – 4%. 

Additionally, because properties often have more available units, commercial real estate offers a smaller vacancy risk.

2. Less Rivalry 

Commercial real estate also has the benefit of having comparatively little rivalry. Commercial investing is thought to be more challenging than other types of investing, hence, there are fewer other investors in this market.

3. Cash Flow 

There’s also a strong and stable cash flow in commercial property. Cash flow is the amount of money a property generates after all costs associated with the operation have been covered. 

Commercial real estate investments are set up to pay investors regular dividends every month, every three months, or every year, but unlike stock distributions, the return is typically higher. 

While stocks might yield an annual compound return of 8–9% to investors, commercial real estate can generate up to 15% in cash flow over the same time period. 

Investors benefit from more advantageous tax treatment on the returns they receive from commercial real estate in addition to the higher cash flow.

4. Good Business Relationship 

The commercial real estate market presents investors with a rare chance to engage in business relationships. 

This may result in more courteous, professional encounters with your tenants. You could even be able to develop relationships with the business owners who rent space in your building in some circumstances. 

Getting connected in the community you are investing in and growing your network are both benefits of doing this.

5. Tangible Asset 

Real estate, as opposed to stocks, which can fluctuate in value, will always retain its underlying worth from the building and the land. 

This tangible asset’s value reflects the possibility of using it to create additional products or services. 

Although property values may increase or decrease, this physical asset won’t change. The investment in commercial property will always be worth it. 

The value of the property will never be zero, even if the rental isn’t paid and there is a change in occupancy. 

Profitability is a possibility as long as there is land. The financial commitment is never meaningless.

6. Inflation Hedge 

Inflation can be protected with commercial real estate. Landowners may raise the rent they demand as the economy expands and prices for products and services rise. 

People can also afford to pay more for rent as their income increases.

According to data gathered by the Federal Reserve Bank of St. Louis, from 2012 to 2016, CRE prices rose by 5% every three months, while the Consumer Price Index stayed at 2%.

7. Diversification of Portfolio 

Investing in commercial real estate helps diversify a portfolio by exposing it to various asset classes and geographical regions. 

This enables the investor to add more diversified investments to their portfolio. Investors secure their income and reduce risk in the case of an economic crisis by diversifying their portfolio by making investments in a range of commercial assets, from retail to industrial.

8. Longer Leases 

Attractive lease contracts are one of the main benefits of commercial real estate. 

Commercial real estate investors enjoy spectacular returns and sizable monthly cash flow. Commercial buildings often have longer lease arrangements with tenants.

9. Tax Advantage 

Investments in commercial real estate may offer the investor a number of tax advantages. Depreciation, which enables you to exclude a percentage of a property’s value from your taxable income each year, is one of the most well-known advantages.

This decreases the entire tax burden. 

Depreciation recapture, where you must pay taxes on the amount you depreciated while owning the property, is still a possibility, but the amount you might save in taxes each year will probably outweigh the tax cost. 

Also, 1031 exchanges may enable you to postpone paying capital gains taxes upon the ultimate sale. 

You can complete the exchange and defer capital gains as long as you invest in another property of a similar type and abide by the other rules. 

Opportunity zone programs were set up to encourage investment in some low-income neighborhoods around the US. 

Similar to 1031 exchanges, these programs give investors the option to defer certain capital gains if they choose to participate in Opportunity Zone Funds until December 31, 2026. 

Non-mortgage tax deductions are another option. Here, you are able to write off operational costs like those for repairs and maintenance. 

Over the course of ownership, general upgrades like renovations depreciate. 

10. Leveraging 

Leveraging is the process through which a commercial property is acquired with the aid of loans rather than in whole. 

In other words, it enables you to buy with less equity. Depending on the cost of debt compared to the cost of equity, this could ultimately enhance the total potential return. 

Leveraging is a strategy used to potentially boost profits by using other people’s money up front, requiring you to invest less of your own money.

Investors may use rental payments as a form of savings plan where the rent pays off the outstanding loan and lowers the asset’s leverage. 

The secret is to use debt sparingly, strike a balance between risk and reward, and make sure that rental income is sufficient to cover monthly mortgage payments. 

Leveraging may still be considered worthwhile by many investors, despite its possible risks.

Compared to other investment options, investing in commercial real estate provides investors with a wide range of opportunities and benefits. 

How To Get Started In Commercial Real Estate 

To get started in commercial real estate, you have to be diligent. No matter what industry or area you operate in, being diligent and doing your research is essential to your ultimate success in real estate. 

Studying extensive business investing will help you understand the commercial real estate market and how it can be different from the residential real estate market. 

If you’re prepared to start your own business, remember to follow these guidelines

1. Recognize The Difference In Commercial Real Estate

Understanding that commercial real estate is valued differently from residential properties is the first step for a beginner in commercial real estate. 

In contrast to residential leases, commercial real estate leases frequently have longer terms. Additionally, money is earned based on usable space in commercial property investing. 

With these, a commercial real estate investor has a higher chance of generating more income. 

Regardless of your area of business, including commercial investing, location is a crucial consideration. 

Commercial investors must, however, also pay particular attention to the kind of tenants they choose. 

When determining demand, two elements come into close contact the location and the planned tenant type. 

For instance, a location meant for corporate offices will probably function better in an urban center than in a neighborhood that is mostly residential.

2. Analyzing Comparables

An analysis of local comparables and future development studies is the best step. These assets, also referred to as “comps,” are the prices paid for recently closed real estate transactions that are comparable in terms of location, size, and style. 

You can estimate a property’s current market value by examining comparable properties. A typical guideline when selecting comparable properties is to pick a home whose square footage is no more than 10% higher or lower than the home being examined. 

The most precise comparisons are then made feasible. 

3. Utilize The Proper Success Metrics

A thorough understanding of real estate financing is required for investing in commercial real estate. 

You need to be familiar with a number of formulas to compete in the commercial real estate market. 

1. Cap Rate 

Also known as the capitalization rate, it is used to determine the value of properties that generate income and will give investors a projection of future earnings or cash flow.

This simply represents the proportion of net operating income to the value of the real estate assets.

2. Cash on Cash 

This measure gives investors a rate of return on their commercial real estate investments. Investors who use financing to buy their properties frequently employ it. 

Cash on cash is a metric used to compare the return on investment made with personal funds to the share that was financed.

This will provide a precise study of the performance of an investment.

3. Net Operating Income 

This is the sum of all the revenues and expenses from a specific property. This statistic, which is calculated before taxes, provides investors with an estimate of how much they will receive from an investment after deducting all essential operational costs. 

Insurance, management fees, utilities, repairs, and property tax are the usual components of operating expenses. 

4. Reserve Cash Contingencies 

In essence, cost contingencies are rainy-day funds set aside to pay for unforeseen purchase costs. 

You can use this part of your spending plan to make up for lost cash flow brought on by early vacancies, renovations, and other upfront expenses. 

For instance, you could need to employ a new property manager or rezone the property. 

These expenses might sometimes be incurred prior to having a steady cash flow. In commercial investing, a typical contingency budget ranges from 5% to 15%. 

Examine the anticipated cash flow during the first few months to establish the appropriate investment amount. 

Will that amount pay for early loan costs? What about alterations to the building? Even if you anticipate early on that your cash flow will be stable, it is always a good idea to have extra money on hand just in case.

Many investors will also set aside a capital reserve fund, which effectively performs the same function later on. 

These funds, which are included in the operational budget, may be utilized for unforeseen costs. 

Overall, you can prevent financial emergencies by budgeting for these expenses throughout the investment process. 

Cost contingencies and cash buffers are essential elements of the commercial investing process.

Common Mistakes To Avoid For Beginners In Commercial Real Estate

It is easy for new investors in the commercial sector to make costly mistakes. Despite the fact that many new investors are initially enthused by the possibility of big returns and seduced by the promise of wealth, they frequently fail to consider the dangers involved and fail to recognize the fact that many property investments fail to yield profits. 

So knowing what to avoid doing as a commercial real estate investor is just as crucial as knowing what to do. The most successful investors of today already understand it, so it’s time you did too.

1. Non-preparation of budget 

If you don’t organize your finances before purchasing a business property, you can find yourself in serious financial trouble when things turn bad rapidly. 

When planning your budget for the purchase of an investment property, keep in mind that you will also need to pay other fees like property taxes, insurance, and furnishing costs in addition to the lender’s necessary down payment. 

2. Poor Planning 

Without appropriate planning, purchasing real estate is likely to be unsuccessful. Buying a business property without thoroughly researching its history and finances is a bad decision that could ruin your finances. 

Consider your financial objectives as you plan your investment path. If you decide that investing in commercial real estate is a viable alternative, you can pick a plan of action and monitor its effectiveness more effectively. 

3. Working Alone 

An excessive number of investors choose to save money by working alone. Working with a team, however, is indisputably superior to working alone. 

While working alone may initially seem to save you money, the likelihood is that you are actually losing money and time. 

Ensure you partner your services with a skilled group and trust them to do the task you assign to them. 

They probably know more about every step of the procedure than you do.

4. Neglecting Due Diligence 

Choosing to purchase real estate without researching market trends is one of the biggest mistakes made by investors in real estate. 

Just like every other investment, you must do extensive research before making an investment in commercial real estate. 

The improper property may be purchased and may cost more than other properties in the region if you don’t pay attention to the necessary market data and trends.

5. Poor Property Location

Location, accessibility, and zoning are crucial elements that can affect a property’s capacity to draw tenants and have a big impact on how well it performs. 

Investors frequently make the error of failing to consider how the characteristics of commercial properties in a particular geographic area affect rentability. 

For instance, if you own office space but companies do not think the location is ideal for opening a store, you can find your investment sitting idle for a while. 

Frequently Asked Questions

Bottom Line

Although investing in commercial property may initially seem overwhelming, you should know that the fundamental skills and abilities needed are the same as those needed for residential property investing. 

They include exercising due diligence, creating a strong network, and creating a proper business strategy that considers financing choices. 

Any sort of investment carries some level of risk, so it’s up to you to figure out how to reduce it. 

You will undoubtedly achieve success if you apply the strategies that helped you succeed in residential real estate to your commercial plan.