types of commercial real estate

 

Commercial Real Estate (CRE) has long been considered an “alternative asset” class, sitting on the periphery of traditional investments such as stocks, bonds, and mutual funds. In recent years, commercial real estate has moved further into the mainstream as a sought-after asset.

For decades, professional investors have made heavy allocations to CRE because it often outperforms all other asset classes (see “Invest Like Harvard: The Advantages of Direct Real Estate Investing”). Add to this level of performance the fact that commercial real estate is the third largest asset class – after stocks and bonds – and a compelling case emerges for inclusion of direct real estate investments into any portfolio.

How are Commercial Real Estate Investments Classified?

Commercial real estate is “vast” in almost every sense. That is good for investors, as it provides numerous entry points into investments and enables investors to easily diversify growing real estate portfolios.

The “Core Four” in real estate are generally viewed as office, industrial, retail, and multifamily. Each real estate property type (or ‘asset class’) can be further divided into subcategories. For example, there are at least five sub-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.

The “Core Four” real estate property types are described below.

 

Commercial Office Space

Office buildings come in all shapes and sizes, from 100-story glass and steel towers in Manhattan to a one-story “bricker” in Muncie. Office properties are generally distinguished by height, location, and use.

Height: There are three height classes that have been adopted by the National Association of Industrial and Office Parks (NAIOP), one of the largest commercial real estate industry organizations in the country, which are as follows:

Low-rise: <7 stories
Mid-rise: 7-25 stories
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, prefer office space with views that can impress clients and attract top talent. Conversely, creative tech users often prefer low-rise buildings with immediate access to their office space, thereby enabling employees to park a bike nearby or enjoy quick access to outdoor space when bringing a dog to the office.

LocationThere are two types of locations:

  • Central Business District (“CBD”)
  • Suburban

Tenants attracted to CBD offices tend to be well-established professional service or tech firms, while smaller or more emerging groups will be attracted to the relatively low rents found in the suburbs.

UseThe “big three” use types include:

  • General Office
  • Medical Office
  • Flex Space

The most common use is general office, which is primarily occupied by professional services tenants. General office buildings will have few specialized tenant improvements. Medical office will attract primarily medical tenants, such as doctors’ offices and hospitals. These properties will have significant tenant improvements to accommodate specialized equipment, hazards, and privacy; therefore, they may be harder to convert to general office if a major tenant moves out. Finally, some space in an office building may be used for heavier, more industrial, logistical, and/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 to qualify as an office property type according to NAIOP.

 

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 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 may also 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 their 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.

Since industrial buildings require substantial acreage for wide building footprints, low-density parking, and truck turning, they are rarely found in the CBD. Therefore, industrial buildings are not distinguished by anything other than use.

 

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 CentersThese 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 CentersNamed 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 centersThese 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 CentersAs 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 sub-type 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 to lease space.

 

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 construction type, multifamily buildings are often classified as follows:

Low Rise or Garden Style: 2-4 stories high
Mid Rise: 5-9 stories
High Rise: 10 stories or higher

In the last several decades, the United States has urbanized, and multifamily properties have become more “institutional” in nature, with costly design and generous amenities. Increasingly, apartment communities are owned by some of the nation’s largest institutional investors, thereby cementing multifamily as one of the four primary commercial real estate asset classes.

To learn more about multifamily investing, click here to download our complete guide.

 

 

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