Understanding the Different Types of Commercial Real Estate

There's been a lot of discussion around "commercial real estate" lately.

For new investors, when they hear commercial real estate, they may automatically think of commercial office buildings, an area that's definitely been in the news for all the wrong reasons since vacancy rates have been hitting new all time highs.

The commercial real estate sector is much more than office space, it's a crucial component of the economy, providing space for housing, businesses, services, and entertainment. Commercial real estate encompasses a wide variety of property types, each with its own unique characteristics, risks, and rewards but there are many successful real estate syndicators and investors across all of the sectors.

As an investor, it's important to understand the different types of real estate classes, the pluses and minuses of each, and which sector best fits into your investor profile.

1. Multifamily Real Estate

This is where Blue Lake Capital focuses. (Shameless plug, check out our new Multifamily Fund.) Multifamily is the bridge between residential and commercial real estate.

While they could serve as a primary residence for multifamily owners, most multifamily properties (especially larger ones) are usually used for investing purposes. The asset class ranges from a duplex all the way up to high rise apartment buildings and townhouse style developments with hundreds of units.

Multifamily buildings are often classified based on their size and amenities, broken down by class:

Class A:

Class A properties represent the high end of the market; generally luxury apartments and condos. Class A properties are typically newer construction, located in the most desirable neighborhoods and feature features amenities that justify their high rents, like high end appliances, well appointed bathrooms, full service gyms, dog parks, rooftop patios and more.

Class B:

This is where Blue Lake is most active; while we do look at Class A properties, we typically focus on Class B/B+ for a variety of reasons.

Class B apartments tend to still be very nice, they just tend to be a little but older and could benefit from some renovations from a good operator (aka value-add). Depending on the vintage of the property, they could rival some Class A properties, but would come with a more affordable rent. They will attract a very strong tenant base, especially if you can find properties in great markets and submarkets that have a strong & resilient job base.

That makes well operated Class B properties very desirable for investors.

Class C:

You may expect to find Class C in developing (or, as the listing will say, "up and coming") neighborhoods.

There's usually a lot of deferred maintenance in Class C properties (e.g., the roof may need replacing, utilities may need to be replaced, etc.). In the units, you'd expect to find things like dated kitchens and bathrooms, carpeting or lesser flooring, and the amenities are nowhere near what you'd find in Class A or Class B+. As an operator, you may deal with more issues around bad debt and vacancies.

Class D:

Most investors would avoid Class D properties. They tend to be in bad areas and show a lot of neglect through a lack of maintenance and upkeep.

Class D apartments tend to be the less desirable parts of town, making it very hard to attract a good tenant base.

The units will look very dated, poorly constructed and will have a lot of maintenance issues.

Office Buildings

As we mentioned, office buildings are perhaps what people envision when they think of commercial real estate.

Office buildings obviously provide space for businesses and organizations to conduct their operations, ranging from small businesses to multinational corporations. Office buildings come in a variety of sizes, from small office suites to massive skyscrapers.

The classification of office buildings is often determined by their age, location, and amenities.

Class A office buildings are typically newer, located in prime areas, and offer high-end amenities, such as on-site parking, 24-hour security, and modern technology infrastructure.

Class B office buildings are typically older, located in less desirable areas, and offer fewer amenities.

Class C office buildings are often functionally obsolete and may require significant renovations or upgrades to be suitable for modern tenants.

Retail

Retail buildings are commercial properties designed for businesses that sell products or services directly to consumers.

This ranges from small storefronts to massive shopping centers and malls. Retail buildings are often classified based on their size and location. Regional malls, for example, are typically large, enclosed shopping centers anchored by major department stores. Strip malls are smaller, open-air centers that often feature a mix of retail and service-based businesses.

Retail buildings can also be classified based on their tenant mix.

Power centers, for example, are retail properties that feature large anchor tenants, such as home improvement stores or supermarkets, and smaller, complementary businesses, such as restaurants and specialty shops.

Lifestyle centers are retail properties that offer a mix of shopping, dining, and entertainment options, designed to create a unique and upscale shopping experience.

Industrial

Industrial buildings are commercial properties designed for businesses involved in manufacturing, storage, warehousing, and distribution. They range from small flex spaces to massive distribution centers. Industrial buildings are often classified based on their size and function.

Class A industrial buildings are typically newer, located in desirable areas, and offer state-of-the-art features, such as high ceilings, loading docks, and advanced security systems.

Class B industrial buildings are typically older, located in less desirable areas, and offer fewer amenities.

Class C industrial buildings may be functionally obsolete and require significant renovations to be suitable for modern tenants.

Industrial buildings can also be classified based on their use.

Manufacturing buildings, for example, are industrial properties designed for businesses involved in the production of goods. Warehouse buildings are industrial properties designed for businesses that require space for storage and distribution.

Hospitality

Hospitality focused properties are designed for businesses that offer accommodations and services to travelers.

They include hotels, motels, resorts, and bed and breakfasts. Hospitality buildings are often classified based on their size and amenities. Luxury hotels, for example, offer high-end amenities, such as fine dining restaurants, spas, and fitness centers, and are typically located in prime areas. Budget motels, on the other hand, offer basic accommodations and are often located in less desirable areas.

Hospitality buildings can also be classified based on their target market. Business hotels, for example, cater to travelers who are visiting for work and offer amenities such as conference rooms and business centers. Resort hotels cater to travelers who are visiting for leisure and offer amenities such as pools, golf courses, and beaches.

Life Sciences

Medical real estate is a specialized category within commercial that includes properties used for healthcare-related purposes.

These properties can range from medical offices and clinics to hospitals, outpatient centers, labs and long-term care facilities. Medical real estate can offer investors several advantages, including stable cash flow, long-term leases, and a growing demand for healthcare services as the population ages. Medical properties can also be attractive to investors seeking to diversify their portfolio and reduce exposure to economic downturns.

However, investing in medical real estate requires specialized knowledge and expertise, as healthcare regulations and financing can be complex. Despite these challenges, medical real estate continues to be a growing segment within commercial real estate, with increasing demand for healthcare services driving continued growth and investment opportunities in this area.

Data Centers

Data centers are another specialized category of commercial real estate that has become increasingly important in recent years.

Data centers are facilities that house computer systems and other telecommunications equipment, providing a secure and reliable environment for data storage, processing, and distribution. With the growing importance of technology and the increasing amount of data being generated and processed, demand for data centers has surged in recent years.

Data centers can offer investors several advantages, including long-term leases with high credit tenants, high barriers to entry, and potential for strong cash flow. Investing in data centers requires significant capital and expertise in the technology industry.

With the continued growth of digital technology and data-driven industries, data centers are expected to remain a key sector within commercial real estate, providing investors with unique opportunities to participate in the rapidly evolving world of technology and information.

Land

Undeveloped land can be considered commercial real estate if it has the potential for commercial development. For example, a plot of land located in a prime commercial area may be suitable for the construction of an office building, retail center, or industrial facility.

While the land itself may not be generating income, its value lies in its potential for commercial use. Typically, you can think about two categories of land in commercial real estate; infill, agricultural and even brownfields.

Infill land refers to undeveloped or underutilized land located within an existing urban or suburban area. This type of land can be attractive for commercial development as it is often in a prime location with established infrastructure and amenities nearby.

Agricultural (or greenfield) land, on the other hand, refers to undeveloped land located outside of urban or suburban areas, often in rural or agricultural areas. This type of land may require additional infrastructure development and may not have immediate access to amenities, but can offer large parcels of land for commercial development, such as industrial facilities, logistics centers, or large-scale retail centers.

Finally, there's brownfield land. This refers to land that was previously used for industrial or commercial purposes and may be contaminated with hazardous materials or pollutants.

Brownfield sites can present significant challenges for development, as cleanup costs can be high, and there may be legal and regulatory hurdles to overcome. However, brownfield sites can also present opportunities for redevelopment, particularly in areas with limited available land for commercial development.

Redeveloping a brownfield site can also have environmental benefits, as it can help to remediate contaminated land and improve the surrounding area. Brownfield sites can be attractive to investors and developers who are willing to take on the risks associated with cleanup and redevelopment, and there are often government incentives and programs available to support brownfield redevelopment projects.

Special Purpose

Special purpose properties can vary widely in terms of their use and value.

These properties are designed for specific uses, such as bowling alleys, parking lots, movie theaters, and other unique types of commercial spaces.

Because they are often designed for a specific purpose, special purpose properties can be challenging to repurpose or redevelop if the original use is no longer viable. However, these properties can be very valuable in certain markets and can be a significant source of revenue for their owners.

For example, a parking lot located in a densely populated urban area can generate significant income from parking fees, while a movie theater with state-of-the-art amenities can attract a loyal customer base and generate revenue from ticket sales and concessions.

Special purpose properties require careful consideration when it comes to investment and development, as their value and potential uses may be more limited than other types of commercial real estate.

Summary

As you can see, each of these categories has its own set of advantages and challenges, and understanding the nuances of each is crucial for real estate investors seeking to make informed investment decisions.

Some properties, such as infill land and special purpose properties, may be more lucrative but come with more inherent risk, while others, like brownfield sites, may require significant investment in remediation and regulatory compliance.

Knowing which type of commercial real estate fits their investing profile, risk tolerance, and long-term goals is essential for investors looking to build a diversified and profitable real estate portfolio. Ultimately, a thorough understanding of the different types of commercial real estate can help investors make smarter investment decisions and maximize their returns.

Once you've done your homework and decided what investments are most attractive to you, the most important step is to just get started.

If you're interested in multifamily real estate, we'd love to connect with you and tell you more about Blue Lake Capital. Just click here to fill out our potential investor form, or send an email to info@bluelake-capital.com and our Investor Relations team will connect with you.

As always, Be Bold, Be Great and Keep Pushing Forward!

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About Ellie Perlman

Ellie Perlman is the founder of Blue Lake Capital, a commercial real estate investment firm specializing in multifamily investing throughout the United States. At Blue Lake Capital, Ellie partners with both institutional and individual investors to grow their wealth by achieving double-digit returns by investing alongside her in exclusive multifamily deals they usually don't have access to.

A defining factor of Blue Lake Capital’s strategy is founded in utilizing machine learning/artificial intelligence throughout the course of all acquisitions and asset management. This advanced technology enables the company to produce accurate and data-driven forecasting for all assets on a market, property, and even tenant basis. In doing so, Blue Lake is able to lead commercial investments with the full capabilities of today’s technology.

Ellie is the founding host of REady2Scale, a podcast that highlights the assets, processes, and strategies for the multiple approaches to successful real estate investing.

She started her career as a commercial real estate lawyer, leading real estate transactions for one of Israel’s leading development companies. Later, as a property manager for Israel’s largest energy company, she oversaw properties worth over $100MM. Additionally, Ellie is an experienced entrepreneur who helped build and scale companies by improving their business operations.

Ellie holds a Masters in Law from Bar-Ilan University in Israel and an MBA from MIT Sloan School of Management.

You can read more about Blue Lake Capital and Ellie Perlman at www.bluelake-capital.com.