You’ve no doubt often heard the terms “commercial property” or “commercial real estate” (“CRE”) when people talk about real estate matters.
But just what is commercial property and what do these terms really mean? And what are some of the other important terms which are used when talking about this major sector of the real estate market?
CRE includes several diverse types of real estate, many with their own unique characteristics and features. Accordingly, being involved with and handling CRE requires a particular knowledge and set of skills to be able to navigate the terminology and nuances to become a successful participant, whether a commercial property investor, lender, or broker.
A good definition of commercial property or CRE
There is no formal definition for CRE, but commercial property can be described as real estate which is used for business activities to generate income and, hopefully, a net profit or return on the investment made to acquire such property.
Commercial property typically refers to buildings that have businesses operating within them but can also refer to land used to generate a profit. In addition, purpose-built residential apartment blocks held for investment purposes by the owners are also considered as commercial properties (“multi-family homes”).
Primarily owing to the nature of occupancy of CRE (i.e., the premises are occupied for business purposes which are considered to have greater risks involved than occupancy for residential use), commercial real estate is expected to provide a higher “return on investment” (“ROI”) compared with properties in the residential sector.
However, entry or acquisition costs when buying CRE are accordingly higher as such commercial property may be in a prime city center location or the overall scale of the building including having many floors or apartment units within.
What are some ways commercial property differs from residential property?
Outside of the physical characteristics that distinguish commercial and residential properties, the key differences relate to the nature of occupancy and the methods of operation of the property in question.
Such differences include:
- in residential properties, the occupants are called tenants and they pay a fixed monthly amount to live on your property. On the other hand, commercial properties are occupied by business-owners and companies—often on exceptionally long leases, some of which may extend to 20 or 30 years;
- commercial properties such as office blocks may be occupied by hundreds if not thousands of people daily;
- there may also be dozens of visitors coming and going to a commercial property, meaning that parking lots or excellent accessibility to highways, subways or bus routes is essential. In short, CRE has heavier use patterns;
- apart from multi-family homes and hotels or other hospitality-based accommodations, most commercial properties do not allow overnight stays;
- owing to demand from occupiers, commercial properties have more up to date technological features; faster fiber optic internet; superior fire, life, and safety systems; an automated Building Management System (“BMS”) monitoring the primary functions of the building’s operation; support from Artificial Intelligence (“AI”) controlling certain functions of the building;
- CRE also must comply with stricter environmental impact and CO2 emissions criteria, during construction, during the life cycle of the building and at the end of its life;
- security standards and facilities will also be superior for most commercial properties with CCTV, finger or eye key scans and a variety of other measures such as security personnel in place to ensure the security of the property but also the safety if its inhabitants;
- importantly, the methods of valuation used to assess the current market value of commercial property differ from those employed for residential property. It is essential to understand terms such as discounted cash flow (“DCF”), internal rate of return (“IRR”) and so on when valuing commercial property.
What are the main types of commercial property?
Commercial property is an all-embracing term and can include but not be limited to:
- high-rise or low-rise office buildings, office parks in suburban areas; co-working spaces or serviced offices for shorter-term occupancy;
- purpose-built medical or dental offices;
- stand alone or street side retail unit(s), community/neighborhood retail centers or large-scale shopping centers; so-called “category killer” or “big box” retailers;
- a hotel or serviced apartment block; a resort or conference center/retreat;
- warehouse, factory, or logistic center’s;
- car parking buildings, garden centers, agricultural land put to commercial use, farms; or
- multi-family homes.
Indeed, almost any property which generates an income for its owner can be deemed commercial property.
Who are the typical owners of commercial property?
Owners of commercial property fall into two categories:
Investors who will buy such property for the benefit of the rental income streams. These may be:
- private individuals or a collection of partners;
- limited liability companies whose primary business is property investment;
- family trusts;
- government related entities (sometimes called “sovereign (or state) wealth funds”) investing in real estate on behalf of its citizens;
- other pension funds placing retirement funds on behalf of its members (teachers, unions) to obtain an investment return
- insurance companies placing proceeds of insurance premiums on behalf of its policy holders;
- religious or military related organizations;
- a collection of investors who come together to acquire CRE either via a property fund or a real estate investment trust (“REIT”).
Then there are owner occupiers who buy a commercial property so as they can self-occupy and run their business from the premises. This means that they have security of tenure (i.e., they are the owner) and are not subject to the whims of a landlord whether to renew a lease or not. They do not have to pay rent, although might have to consider loan repayments to a bank or other financial entity if they have borrowed money for the purchase.
Commercial property is a fascinating sector of the real estate market. There are many different asset types involved and so many variable factors affecting what makes a CRE property successful!