Commercial Real Estate BasicsCommercial real estate and residential real estate comprise two main categories of real estate. Residential property includes structures intended for human habitation and not for commercial or industrial use. As the name suggests, commercial real estate is used for commerce, while multi-unit rental properties that serve as residences for tenants are classified as commercial activities by their owners.

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Commercial real estate is typically categorized into four classes, depending on its function:

• Office space

• Industrial use

• Multifamily rentals

• Retail

 

Individual categories can also be further classified. For example, there are several different types of retail real estate:

• Hotels and resorts

• Strip malls

• Restaurants

• Health facilities

 

Similarly, office space has several subtypes. These are often designated as Class A, Class B, or Class C:

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Class A buildings represent the best in terms of aesthetics, age, infrastructure quality, and location.

Class B buildings are typically older and not as competitive—price-wise—as Class A buildings. Investors often target these buildings for restoration.

Class C buildings are the oldest, typically more than 20 years old, located in less attractive areas, and in need of maintenance.

Note that some zoning and permitting authorities further break down industrial properties—sites used for the manufacturing and production of goods, especially heavy goods—but most consider them part of commercial real estate.

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Commercial Lease

Some businesses own the buildings they occupy. However, commercial properties are more commonly leased. Typically, an investor or group of investors owns a building and collects rent from each business operating there. Commercial lease rates—the price to occupy space for a specified period—are typically quoted in annual rent dollars per square foot. In contrast, residential real estate rates are quoted as annual or monthly rent amounts.

Commercial leases typically last from one year to 10 years or more, with office and retail spaces typically averaging five to 10 years.

 

This can be contrasted with shorter-term annual or monthly residential leases.

A study by real estate market analysis firm CBRE Group found that the term—that is, the length—of a lease is proportional to the size of the leased space.

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Furthermore, the data shows that tenants will enter into long leases to lock in prices in a rising market environment. But that's not the only motivating factor. Some tenants with large space needs will enter long-term leases due to the limited availability of properties that meet their needs.

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There are four main types of commercial property leases, each requiring different levels of responsibility from both landlord and tenant.

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A single net lease makes the tenant responsible for paying property taxes.
A double net (NN) lease makes the tenant responsible for paying property taxes and insurance.
A triple net (NNN) lease makes the tenant responsible for paying property taxes, insurance, and maintenance.
Under a gross lease, the tenant pays only rent, and the landlord pays property taxes, insurance, and building maintenance.​

 

Managing Commercial Real Estate

 

Owning and maintaining leased commercial real estate requires full and ongoing management by the owner. Property owners may want to hire a commercial real estate management company to help them find, manage, and retain tenants, oversee leasing and financing options, and coordinate property maintenance and marketing. Specific knowledge of a commercial real estate management company is helpful, as the rules and regulations governing such properties vary by state, county, municipality, industry, and size.

 

Landlords must often strike a balance between maximizing rents and minimizing vacancies and tenant turnover. Turnover can be costly for CRE owners because the space must be adapted to meet the specific needs of different tenants—for example, if a restaurant moves into a property formerly occupied by a yoga studio.

 

How Investors Make Money in Commercial Real Estate

Investing in commercial real estate can be potentially profitable and serve as a hedge against stock market volatility. Investors can make money through property appreciation upon sale, but the majority of returns come from tenant rents.