As the third-largest asset class in the U.S. behind stocks and bonds, real estate covers a lot of ground. Commercial real estate (CRE) is a subset of real estate and includes everything from senior memory care to package fulfillment centers to dry cleaners. The vast majority of businesses need a physical space to operate, and that means endless variety of investment opportunities for those looking to add real estate to their portfolio.
The breadth of the CRE category offers investors many different entry points and makes it easier to diversify as their real estate portfolios grow. But the abundance of options can feel overwhelming without a good grasp of the basics of the sub-classes within CRE.
Commercial real estate is generally divvied up into the “four basic food groups” of office, industrial, retail, and multifamily. Each asset class can be further divided into multiple sub-categories. Retail, for example, can be split up into more than half a dozen types of investment properties. There are also a number of more “niche” asset classes that don’t fit neatly within the big four, including hotels, self-storage, medical office, senior housing, student housing, and land. Nearly every property type can also be divided by quality, labeled as Class A, B, or C.
Understanding a potential investment’s asset class and the economic factors affecting that type of property can help you better evaluate if the deal is right for your portfolio.
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.
Employment growth is a big demand driver for office, especially in those industries that are heavy office users like finance, insurance, or tech.
Colliers and NAIOP, one of the largest commercial real estate industry organizations in the country, categorizes office into three height classes:
Low-rise: <7 stories
Mid-rise: 7-25 stories
High-rise: 25+ stories
Certain types of tenants will naturally prefer one height class over another. Big law firms, for example, might prioritize views to impress clients and attract top talent. On the other hand, creative tech users often prefer lower-rise buildings for the easy access to their office space to park a bike or bring a dog, and may not want to share space with the “old economy” tenants more often found in high-rise offices.
The next office classification, location, consists of two types: central business district (CBD) and suburban—think the heart of Manhattan versus Westchester, NY. While you might find the full spectrum of heights in the CBD, lower rents in the suburbs generally make the construction of high-rise and even most mid-rise buildings cost-prohibitive, which is why buildings tend to be shorter. But cheaper land means it’s easier to build out with an office park instead of up with a high-rise. 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 tenants primarily in white-collar professional services and/or tech. General office buildings will have few specialized tenant improvements. The sub-asset class of medical office, however, might have significant tenant improvements and custom floor plans to accommodate specialized equipment, hazards, and privacy. Think dialysis centers or private practice doctors’ offices. These properties may be harder to convert to general office in the event that a major tenant moves out.
The final office subcategory is known as flex space, where a portion of an office building is used for heavier, more industrial or technological uses. 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.
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Industrial
The industrial sector is arguably the least glamorous commercial real estate asset class. There are no elaborate architectural design features, resort-like amenities, or high-profile addresses. Instead, industrial real estate is intended to provide practical and efficient space to businesses that prioritize function over form. Industrial buildings are suitable for a variety of uses such as manufacturing, research and development, and the storage and distribution of goods.
Demand for industrial assets is heavily dependent on the overall strength of the economy and growth—the more people shopping, shipping, and storing, the more industrial space is needed. Warehouse space in particular is also affected by export and import activity.
The National Association of Industrial & Office Parks (NAIOP) breaks industrial into three categories:
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 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 their 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. Many real estate professionals consider data centers to be part of this category.
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Retail
Retail property types range from single-tenant buildings, like a stand-alone pharmacy, to full shopping centers with dozens or even hundreds of tenants. Retail centers that have more than a single tenant are grouped by size and tenant type.
Demand for retail space is driven by consumer spending habits and trends.
The International Council of Shopping Centers (ICSC), the largest retail industry organization in the world, splits retail into five categories:
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 like Macy’s or 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. These centers are often “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 like Best Buy, Dick’s Sporting Goods, or Bed Bath & Beyond, with only a smattering of smaller tenants.
Lifestyle centers: As enclosed malls became too expensive to build, a new generation of open-air lifestyle centers began to gain popularity. They feature upscale apparel and other retailers, along with dining and entertainment.
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Multifamily
In the past, multifamily properties (think apartment buildings) were more often grouped with other residential assets like single-family homes than rolled in with commercial real estate. However, multifamily assets now account for the second-largest share of institutional investors’ holdings behind the office sector, making up roughly 20% of the U.S. commercial real estate stock.
Population growth—especially among demographics more likely to be renters—has a big effect on demand for multifamily. With the number of renters in the U.S. increasing, the range in apartment property offerings has expanded to fit their varied needs and tastes. Size, density, location, and amenities break up the multifamily asset class.
In terms of size, 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
Multifamily also covers a number of niche asset classes for specialty markets. Student housing is a multifamily property built close to an anchor college or university designed to attract the students there who don’t live in the dorms. They often have amenities like pools, game rooms, fitness centers, and even on-site restaurants and retail designed to ease the transition to life off-campus.
Another, newer property type within multifamily is Build-to-Rent (BTR). Build-to-Rent takes the best aspects of single-family rentals and upgrades the experience by developing all homes inside a professionally managed community. They’re similar to traditional, gated residential neighborhoods with great community amenities—swimming pools, tennis courts, dog parks—and professional management without burdening residents with HOA costs or a mortgage.
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Hospitality
The main type of property within the hospitality moniker is hotels. Hotels are defined primarily by the services and amenities that they offer, but also by the “flag” or operating brand of the property. This includes brands like Holiday Inn, Hilton, and Marriott, among others.
Unsurprisingly, travel and tourism activity in a specific market drive the demand for hospitality assets in that location.
The three main types of hotels include:
Full-Service: These high-end hotels are loaded with guest services and amenities, including on-site restaurants, banquet and meeting rooms, concierge service, spas, and retail shops. For full-service hotels, the overall success of the hotel is highly sensitive to the quality of its on-site 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 hotels 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.
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Senior Housing
The aging Baby Boomer population is attracting more investment capital into this sector in terms of acquisitions, development, and property renovations. Senior housing properties aim to provide both housing and services to seniors, and are generally split up into categories based on the level of care provided.
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 healthcare 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 mental 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.
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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.
Demand drivers for self-storage assets include population growth and density, average household size, and average household income.
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.
