Commercial real estate was long considered an “alternative asset” class that floated on the periphery of traditional investments such as stocks, bonds, and mutual funds. In recent years, commercial real estate has increasingly migrated into the mainstream as a sought after asset. This migration has been reinforced by the fact that professional investors have used it heavily in portfolio allocations for decades and that commercial real estate often outperforms all other asset classes (see my previous article on post modern portfolio theory). Add to this level of performance the additional fact that commercial real estate is the third-largest asset class (after stocks and bonds) and now a compelling case emerges for inclusion of direct real estate investments into any portfolio. As investors are now discovering and embracing direct real estate investments as an enviable part of an investment portfolio, it raises a series of questions on defining subsets within the greater asset class.
Commercial real estate is vast in almost every sense. That is actually good for investors as it provides numerous different entry points into investments, and it enables investors to easily diversify growing real estate portfolios. The “four basic food groups” in real estate are generally viewed as office, industrial, retail and multifamily. Each real estate property type (in the industry referred to as ‘asset classes’) can be further divided into sub-categories. For example, there are more than a half dozen types of retail investment properties. In addition, there are numerous other property types outside of the core four, including hotels, self-storage, medical office, senior housing, student housing, and land, among others. Finally, nearly every property type can be divided by quality, labeled as Class A, B, or C. Some of the main real estate property types are described below.
Office
Office buildings come in all shapes and sizes from 100-story glass and steel towers in Manhattan to a one-story bricker in Des Moines. Office properties are generally distinguished by height, location, and use.
The height classes that have been adopted by Colliers and NAIOP, one of the largest commercial real estate industry organizations in the country, are as follows:
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Low-rise: <7 stories
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Mid-rise: 7-25 stories
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High-rise: 25+ stories
The tenants that office buildings attract may, in some cases, depend upon the height. Consider that certain office users, such as law firms, like office space with views that can impress clients and attract top talent. Conversely, creative tech users often prefer immediate access to their office space to park a bike or bring a dog and therefore don’t generally like to be in an office tower that probably shares space with “old economy” tenants, such as that law firm, especially if the creative user feels the vibe of the building is stiff. While office space is evolving, it’s still a challenge to have people in suits, bikes, and dogs share the same elevators. Furthermore, these structures will vary in materials, cost to construct, and maintenance issues.
The next office classification, location, consists of two types: Central Business District (“CBD”) and suburban. While you might find the full spectrum of heights in the CBD, lower rents in the suburbs generally do not support the most costly construction techniques that high-rise and even most low-rise buildings require. Tenants attracted to CBD offices tend to be more established professional service or tech firms, while smaller or more emerging groups will be attracted to the relatively low rents found in the suburbs.
Finally, office buildings vary by use. The most common is general office use, with primarily tech and professional services tenants. General office buildings will have few specialized tenant improvements. Medical office, another office subtype, will attract primarily medical tenants, such as doctors’ offices and hospitals. These properties might have significant tenant improvements to accommodate specialized equipment, hazards, and privacy; therefore, they may be harder to convert to general office in the event that a major tenant moves out. Finally, some space in an office building may be used for heavier, more industrial or technological uses. This is known as flex space. Overall, at least 75% of a building’s interior space needs to be designed and finished as office space in order to qualify as an office property type according to NAIOP. This distinction becomes important when reading about market trends. Office categories are defined in more detail by the Building Owners and Managers Association International (BOMA) and NAIOP.
For more detailed information on office please see our article How to Invest in Office Real Estate.
Industrial
Industrial buildings are used for functions such as manufacturing, R&D and the storage and distribution of goods. The three main categories are manufacturing, warehouse and Flex/R&D, which are defined as follows by the National Association of Industrial & Office Parks (NAIOP):
Manufacturing: A facility used for the conversion, fabrication and/or assembly of raw or partly wrought materials into products/goods. These properties tend to have less than 20% office space and can be further classified for a heavy or light industrial use.
Warehouse: A facility primarily used for the storage and/or distribution of materials, goods, and merchandise. These buildings tend to have less than 15% office space, and modern facilities have high clear ceiling heights that allow for more cubic storage space. This category also may include specialty facilities, such as cold or freezer storage for food.
Flex/R&D: These industrial buildings are designed to give its occupants flexibility in the use of the space. Sometimes referred to as flex/tech space, these buildings are an office-industrial hybrid that can have 30% to even 100% office finish.
Because they require a lot of acreage for wide building footprints, low-density parking, and truck turning, industrial buildings are almost never found in the CBD. Therefore, it is rare to hear them distinguished according to anything other than use.
For more detailed information on industrial please see our article: How to Invest in Industrial Real Estate.
Retail
Retail property types range from single-tenant buildings, such as a Walgreens, to large mega-malls. High-rise buildings are almost never used solely for retail; instead, only a portion of a high-rise building, typically at ground level, will be used as a retail component. Retail centers that have more than a single tenant are grouped by size and tenant type. The International Council of Shopping Centers (ICSC), the largest retail industry organization in the world, defines different types of shopping centers as follows:
Malls: Regional malls range in size from about 400,000 to 800,000 square feet and include inline retail, service and restaurant tenants, as well as major department store anchors, such as Macy’s and Nordstrom. Super regional malls are upwards of 800,000 square feet.
Community & Neighborhood Centers: These centers include a mix of general merchandise or convenience-oriented tenants. Oftentimes, these centers are “anchored” by a big box retailer such as Target, Walmart or a grocery store. These centers might range in size from 30,000 to 400,000 square feet.
Strip centers: Named for their straight configuration, these centers generally focus on convenience tenants such as dry cleaners, nail salons and sandwich shops. Strip centers are smaller than 30,000 square feet.
Power centers: These centers are dominated by “big box” retailers such as Best Buy, Dick’s Sporting Goods and Bed Bath & Beyond with only a few small tenants.
Lifestyle Centers: As enclosed malls became too expensive to build, it created a new generation of open-air lifestyle centers that feature upscale apparel and other retailers, along with dining and entertainment.
One of the most important aspects of the retail subtype is its dependency upon traffic and parking. Urban retail spaces, which usually are a portion of a mixed-use building rather than a single-use building, rely heavily upon foot traffic, while strip centers rely heavily upon vehicle traffic. Lifestyle centers, on the other hand, will create their own traffic because the anchor tenants are usually “destination tenants,” such as movie theaters and restaurants. Except for the most densely urban locations, almost all retail tenants require certain minimum parking to square footage ratios in order to lease space.
Another important feature of retail properties is the tenant mix. While multifamily and office tenants generally do not care who their neighbors are as long as they are quiet, retail tenants thrive off certain neighbors and refuse to be located near others, usually competitors. For example, you may commonly find a Jo-Ann Fabrics located in the same shopping center as a Big Lots or a Dollar Tree. This strategy is referred to as adjacencies. Having an appropriate tenant mix is something of an art in the retail industry.
For more detailed information on retail please see our article: How to Invest in Retail Real Estate.
Multifamily
Apartment properties also come in all shapes and sizes, ranging from dense, high-rise, urban apartment buildings to sprawling, resort-style complexes in the suburbs complete with swimming pools, fitness centers, and outdoor patios.
In terms of size, multifamily buildings are often classified as follows:
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Low Rise or Garden Style: 2-4 stories high
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Mid Rise: 5-9 stories
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High Rise: 10 stories or higher
In the past, multifamily properties were regarded less as commercial real estate assets and more closely associated with other residential assets such as single-family homes. However, in recent years as the US has increasingly urbanized and multifamily properties have become more institutional in nature with costly design and vast amenities and now increasingly owned by some of the nation’s largest institutional investors, multifamily is now firmly cemented as one of the four primary commercial real estate asset classes (the other primary three being office, industrial and retail).
For more detailed information on multifamily please see our article: How to Invest in Multifamily Real Estate.
Hotels
Hotels are defined primarily by the services and amenities that they offer. Another key distinction in this category is the “flag” or operating brand that includes the likes of Holiday Inn, Hilton, and Marriott among others. The three main types of hotels include:
Full-Service: These hotels are loaded with guest services and amenities, such as on-site restaurants, banquet and meeting rooms, concierge service, spas, and retail shops. Some examples include the Hyatt, Ritz-Carlton, St. Regis and Westin. For full-service hotels, the overall success of the hotel is highly sensitive to the quality of its onsite amenities, particularly the food and beverage services.
Limited-Service: These properties are a step down in terms of service and amenities, often including meeting rooms, a fitness center, and a swimming pool. As a result, the operations of this class of hotel are more predictable in comparison to full-service hotels. Some examples include Fairfield Inn, Hampton Inn, and Holiday Inn Express.
Budget: These “no frills” hotels may offer one or two guest services or amenities, but they tend to focus on providing the basic necessities for a very low rate. Examples include EconoLodge, Super 8 and Starwood’s Aloft.
For more information on hospitality please see our article How to Invest in Hotel Real Estate.
Senior Housing
The aging baby boomer population is attracting more investment capital into this sector in terms of acquisitions, development and property renovations. The National Investment Center for the Seniors Housing & Care Industry (NIC) is an industry association that offers a variety of research and resources for investors, owners, and operators. The different categories of seniors housing facilities include:
Independent Living: Designed for seniors who require little or no assistance. These properties often cater to residents who are 55+ with a variety of on-site amenities and social programming for active seniors.
Assisted Living: These licensed facilities combine housing with a variety of personal support services, such as transportation, meals, laundry, and health-care assistance.
Nursing Homes: Properties are generally licensed and provide 24-hour skilled care for chronic and short-term conditions that require medical and nursing care.
Memory care: The long-term care facilities are designed for people with a level of impairment, such as dementia, that makes it unsafe for them to continue to stay at home, but who do not require the intensive care of a skilled nursing facility.
For more information on senior housing please see our article How to Invest in Senior Housing Real Estate.
Self-Storage
Self-storage is a segment of the real estate market that has continued to evolve in the past decade. The traditional rural and suburban properties with gravel driveways and roll-up metal doors are being replaced with modern facilities and sophisticated operators.
Developers have been busy building and converting urban, multi-story properties that feature climate and humidity-controlled space and high-tech security systems. In addition to providing storage to individual and business customers, some facilities also offer specialty storage for boats, classic cars, wine, and documents.
For more information on self-storage please see our article How to Invest in Self Storage Real Estate.
Single-family Residential (in bulk)
The housing market crash helped to bring a wave of opportunistic investors into the single-family rental market. Investors bought homes at a discount and converted them to rental properties to serve a growing population of renters. This niche market now includes institutional investors and REITs, as well as professional property managers that oversee the rentals and day-to-day operations of these properties.
Getting Starting in Commercial Real Estate Investing
Commercial real estate investment has historically been limited to deep-pocketed investors, typically those with a minimum $250,000 to invest in each deal. Thanks to the 2012 JOBS Act and new software which enables real estate syndications at scale, CrowdStreet is now able to provide access to commercial real estate investment offerings.
