Commercial real estate is land on which a business can be operated for revenue. As opposed to residential real estate, which can only be used as a primary residence or for rental housing, commercial real estate is designated by law as property intended for a business to generate income. Income from commercial real estate can come from charging rent to businesses or individuals that lease the space, or from the owner running a business on the property themselves.
What is commercial real estate?
Local laws stipulate which areas are designated for commercial use and which are for residential use through a process called zoning. Residential areas comprise housing for single or multiple families and have minimal traffic and noise. Commercial areas allow for a wider range of building types and business activities, which may otherwise interrupt daily living if not separated from residential housing areas.
Buildings in a commercial area must house a business or businesses. In urban environments, this can be in the form of large office buildings rented out by many different businesses, or facilities that charge rent to multiple patrons – such as self-storage or medical office buildings. Commercial real estate in suburban areas often consists of a single business per building, such as a car wash or restaurant. In both cases, the owner of the real estate will receive a reliable rent income, or may elect to operate an enterprise of their own.
Types of commercial real estate
Office buildings contain workspaces — generally corporate or professional enterprises (as opposed to retail or manufacturing). Office space is commonly divided into three classes.
- Class A is the top classification of office buildings. Class A office buildings will typically be in a high demand area, have modern stylings and may have been built or fully remodeled recently, with top of the line infrastructure and a variety of services and amenities that are attractive to companies. These buildings offer the advantage of luxury, location and new construction.
- Class B occupy the margin between Class A and Class C buildings: They represent a balance between cost and quality. These may be in areas of modest demand. Their structure and interior are kept in good repair, but aren’t the most lavish or state-of-the-art.
- Class C office buildings may be the most affordable to acquire but often land on the lower end of the spectrum for finishes, business demand and profitability. They may be located on the outskirts of a city or suburban business district, have very few amenities and may require more extensive renovation of interiors and exteriors.
Industrial buildings can range from heavy manufacturing to light assembly facilities; they also can include storage and bulk warehouse structures. This is one of the most regulated forms of real estate. Industrial zoning rules can be very complex, depending on the type of industry involved: Oil refineries, for example, can’t be built in just any area that is zoned for industrial use. Depending on the city and state regulations, as well as the area of interest, industrial use for commercial properties can be more or less feasible.
Commercial real estate used for retail covers everywhere you shop and pay for goods or services including:
- Shopping centers and malls
- Restaurants, bars
- Hair salons and spas
- Department stores and clothing boutiques
- Gyms, sports centers
- Any other establishment where you might spend money
While commercial real estate is usually contrasted with residential real estate, multifamily dwellings (apartment buildings, rowhouses, assisted living facilities, etc.) are kind of a hybrid: Yes, people live in them, but they represent a business and generate income for the person or entity that owns them. Basically, buildings or groups of buildings with five or more residential units are actually designated as commercial, not residential, properties. Buildings with one to four rental units typically still fall under the classification of residential real estate — although those in financial circles consider them as investment properties (just to add to the confusion).
For this reason, local zoning laws often go further than just slotting areas for residential or commercial use, but often sub-divide them further as either for single-family or multifamily dwellings. That’s why commercial development of new apartment complexes often tends to cluster in certain neighborhoods or areas of a municipality.
How can you invest in commercial real estate?
Direct or active investment in commercial real estate means owning and managing a property yourself. You can invest in real estate directly by working with a real estate agent or attorney to research options, pick out a property, and make an offer. You’ll typically need to have significant assets to finance your purchase or work with a lender specializing in commercial real estate loans. You may also structure a syndication around a particular commercial investment opportunity to raise funds from an entire group of investors.
If managing a building or structure is too much work or risk for your preferences, you can also invest in real estate indirectly: not by purchasing physical property yourself, but by buying a stake in a company or partnership that does. People who participate this way are known as passive real estate investors. They share in the income and profits the real estate generates, but don’t make any decisions about it.
A real estate investment trust (REIT) is essentially a publicly traded company that invests in real estate: You buy shares in it as you would any stock. REITs are available for all types of real estate, so you could narrow down your investment choice to just Class A buildings, for example.
In addition to REITs, you can invest indirectly through different real estate partnerships and crowdfunding platforms. You might invest capital in a syndication, or opt to purchase units of an investing fund to diversify your capital into multiple asset classes for even lower overall risk. Passive investors are commonly considered limited partners — “limited” in that they don’t participate in management, they just put up money — but can also become partners in a joint venture, or conduct private money lending (although the latter two are less common with commercial investment properties).