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What is commercial real estate?

| Nov 10, 2020 | Firm News |

Real estate falls into two classifications which impact its use and transactions. Commercial real estate, unlike residential real estate, is used exclusively for business purposes, provides a place to work or generates income. Investing in CRE usually requires more investor sophistication and capital.

Basics

There are four classes of commercial real estate based on its function. These are office space, industrial use, multi-family rental and retail.

Individual categories also have four classifications. Office space, for example, has the following classifications:

  • Class A is the best building based upon aesthetics, age, infrastructure quality and location.
  • Class B buildings are generally older, have less competitive pricing and are usually intended for renovation.
  • Class C buildings are the oldest, typically over 20 years, need maintenance and are in less attractive locations.

Leases

Usually, commercial property is leased. An investor or group of investors own the building and collect rent from each business that operate their businesses there. Commercial lease rates, the price for occupying a space for a stated time, is usually quoted in annual rental dollars per square foot.

Leases usually run from one to 10 years or more. Office and retail space usually have five and 10-year leases, on average.

A single-net lease holds the tenant responsible for paying property taxes. A double net lease has the tenant responsible for property taxes and insurance. Under a triple net lease, the tenant must pay property taxes, insurance, and maintenance. In a gross lease, the tenant pays rent while the landlord pays property taxes, insurance, and maintenance.

Advantages and disadvantages

Attractive leasing rates in areas where land or law restrict new construction is a great advantage. Commercial real estate may have impressive returns and substantial cash flows. Industrial buildings usually rent at lower rates although they have lower overhead costs.

Commercial real estate also has longer lease contacts. This provides real estate holders with considerable cash flow stability if long-term tenants occupy the building. It also has the potential for capital appreciation if the property is well-maintained and kept up to date.

Disadvantages include complicated and different laws on taxes, purchasing and maintenance responsibilities. The possibility of tenant turnover is another problem especially in an economic atmosphere where unexpected retail closures result in vacancies with little advance notice.

Tenants can have different needs requiring expensive renovations. Each space may need adaptation to meet a tenant’s particular business needs. High tenant turnover, however, may be expensive because of the renovation costs for incoming tenants.

Attorneys can advise and assist parties in these transactions. They can also help protect their interests.