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Commercial real estate is a term that covers a broad spectrum of asset types, classes, locations, and markets. It is an industry that institutional investors have had access to for some 30 years or so, that high net worth individuals have been investing in for generations, and that, due to recent regulatory changes, accredited investors nationwide can get involved with for the first time in history.
Even after a year in which the global economy was shaken to its core by an unprecedented pandemic, the demand for commercial real estate has continued upwards as seasoned, and new investors alike try to find opportunities resulting from the shakeup. The opportunities are there, and in this article we outline and categorize the different types of commercial real estate and then dive into some of the different asset class nuances.
The demand for commercial real estate is growing due to multiple factors. Baby boomers are leaving the workforce and demanding residential communities to retire into, millennials are utilizing technology to establish new businesses, and population growth, both within the existing citizenry, includes many entrepreneurial first-generation and naturalized Americans.
Beyond merely demographic shift, advancements in technology, the implementation of incentive-driven tax policies, and the emergence of industries that had not existed only a decade ago are resulting in economic opportunities in places where they did not exist earlier.
For example, in recent years, particularly since the beginning of the 2020 pandemic, reliable access to high-speed internet has become an absolute necessity for businesses. This access has only recently reached the levels where businesses can use it without concern that poor connectivity will cause problems.
The impact on commercial real estate that this trend has had is to expand accessibility to effective communications through the internet to a far larger swath of the country, making previously impractical locations now ready for commerce and growth – and with that an increase in demand for commercial real estate to house the growing demand.
A look at the chart below shows that in an incredibly short period of time, U.S. internet service providers realized they had to increase their performance or risk losing customers to competitors who were doing what they did not or could not.
The most significant result of increased broadband access has been that secondary or tertiary markets outside of cities and metropolitan areas are now in play for businesses that want to establish a physical location. Cheaper rents and lower overall cost of living allow businesses to attract employee talents through higher wages, more generous benefit packages, and improvements to the structures where employees work.
In turn this drives demand for more and higher quality residential multifamily communities, senior housing facilities as families migrate away from urban centers, and for hospitality assets as people seek new places to spend their free time.
In turn this drives demand for more and higher quality residential multifamily communities, senior housing facilities as families migrate away from urban centers, and for hospitality assets as people seek new places to spend their free time.
Different markets are bound to require different levels of each type of asset and the pie charts below contrasts asset classes between cities and suburbs
Lastly, and most simply, the population is at an all-time high. This mixture of new industries fueled by increased access to technology, a departure of baby boomers from the workforce, and an increased population with many first-generation Americans and naturalized citizens that came here due to their entrepreneurial spirit are all fueling the increased demand for commercial real estate.
Commercial office space is not dead, as many pundits and talking heads prematurely suggested earlier in the pandemic. Despite an increase in telecommunications, businesses will remain in need of headquarters and satellite officers to nurture rising talent and expand into new markets.
According to real estate services company, JLL, there are many reasons to be bullish about demand for office space:
Supporting these indicators, absorption rates are predicted to recover by the end of 2021, as detailed in the chart below.
Indeed, internal resesarch at Alphabet Inc, the parent company of Google, shows that over 75% of their employees want more collaboration and social connections while working and seek physical proximity to co-workers when working on new projects. These findings are consistent with the experience other businesses across the economy; people like working in close proximity to others because they find they can be more productive working in groups and prefer the human connections working out of an office provides.
Reinforcing this thesis, research by Trepp, the commercial real estate services company, found that, as of Q3 2021, office tours in major gateway cities like Boston, Chicago, Los Angeles, New York City, Seattle, San Francisco, and Washington DC, increased by almost 30% indicating a significant uptick in demand and return to pre-COVID levels. The Trepp study also found that 70% of leasing activity is coming from renewals suggesting that despite the impact of the pandemic, most companies are staying put.
As demand for downtown office space continues to recover for the reasons mentioned above. Suburban office space is also seeing a resurgence in demand for similar reasons. They are getting an extra boost for other reasons.
As workers age and start families, they often want to relocate to areas with more affordable property and better school districts and with the increasing acceptance for both remote and hybrid working, companies are finding benefits from locating some of their employees outside of heavily populated, downtown locations.
Satellite offices in the suburbs allow businesses to retain and relocate experienced workers without forcing them to choose between their personal and professional lives or to suffer unecessarily lengthy commutes from the suburbs to downtown locations. This is especially true in cities where public transportation is the primary method employees use for their commutes and where this became impractical during the pandemic.
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In terms of real estate, no industry was hit harder by the COVID pandemic than the hospitality industry. This economic pain is not something that will continue forever as travel for business and pleasure is closely intertwined with American economics and culture.
Furthermore, while the hospitality industry is often the first to suffer during any kind of economic malaise, it is also among the fastest to recover as pent up demand from consumers returns as they celebrate an economic recovery or, as with the pandemic, finally are able to travel once again from the isolated lifestyles lockdowns enforced.
Increased cleaning costs, consumer health concerns, and local social distancing measures have all combined in the short term to hurt the profitability of the hospitality industry, but it is by no means done for.
Indeed, we are seeing a rare opportunity to acquire distressed hotels where previous management struggled to cover costs and are now forced to sell their assets to cover mounting debt burdens. As the economy recovers, these opportunistic acquisitions present bargain pricing right at the moment the market is turning and is one we are turning our resources to developing before the window closes and pricing catches up with true market values.
As the chart below shows, the market has already entered the recovery period, and investors will be able to take advantage of the uncertainty to find great opportunities for a limited amount of time.
Full-service hotels have long provided a variety of amenities that make them popular with business travelers, families, and even out-of-town organizations in need of a central location for an annual conference.
Full-service hotels are familiar brand names such as Marriott, Hilton, and Hyatt. These brands have a proud history of doing much more than simply providing a clean room and often market themselves as knowledgeable guides to getting the best experience possible in their home area.
Beyond the services they provide for their guests, full-service hotels often compete with businesses in the local market with in-house restaurants, bars, lounges, and performance spaces designed to generate revenue from those who will likely never need to book a room in their facility.
The overhead for this asset class is substantial, and these types of hotels are only found in locations that bring in upper-class vacationers or business people. The need for security, bellhops, kitchen staff, event coordinators, and other operational staff requires room rates that fetch a premium price.
Despite higher rates, this asset class stands alone in its ability to provide services to the business community and elite travelers, ensuring that full-service hotels are here to stay for the foreseeable future.
Limited-service hotels provide a balance of value and service for travelers who may be vacationing on a budget with children, in town for a wedding, or those traveling for work who don’t intend on taking in any of the local attractions beyond a good restaurant recommendation.
Familiar brands in this category are Ramada Inn, Holiday Inn Express, or Comfort Inn.
Operational costs for these buildings are substantially smaller than full-service hotels as the scope of their offering is limited to safe and clean sleeping quarters with the occasional tip on information about the local surroundings.
Motels, or budget hotels, are a staple of the American travel experience that have remained present and profitable in the market for decades. Consumers have little to no expectations of the staff providing anything beyond a key to their room and a receipt that they paid the bill.
The most familiar brand, Motel 6, and their iconic slogan “We’ll leave the light on for ya’” have, among others, remained present in the hospitality market for decades. This is precisely due to their extremely low operational costs that align with customers' expectations of service offerings.
These assets are cheap and easily improved due to their 1-3 story structures but often don’t require any CapEx from new owners as the consumer expectations don’t go much further than clean sheets.
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Multifamily assets include a variety of building designs, locations, and asset classes. Two-story, suburban, multi-building apartment complexes and center-city high rises are both classified as multifamily, and both continue to deliver investors healthy profits for clear reasons.
As particular communities grow in popularity, the amount of available land remains the same. Rather than building out and decreasing value as units get further from desirable school districts and transit points, developers are more frequently building up. This allows developers to provide popular locations to larger numbers of residents and retain their ability to charge premium rents for premium locations.
Mid-rise apartments have 5-12 floors and provide services that consumers have historically associated with big-city high-rises. Buildings of this size make it economical to provide services like on-site gyms, parking, security, and maintenance teams to improve residents’ experience.
While traditionally only found in and on the outskirts of major city centers, smaller cities are more frequently getting into the mid-rise game as well. To capitalize on their growing popularity and solve their housing shortage, planning departments are rezoning to allow for standalone mid-rise apartments and mixed-use structures that offer retail space at street level with many potential customers for the retail just above their heads.
High-rise buildings had traditionally been limited to urban centers, but over the last 50 years, they have increased in suburban areas. These increases align with high-income residents who commute to urban centers and aging populations for whom senior living was unavailable.
As high-rises expect to charge premium rates, they often offer concierge services included within the rent that would seem extraordinary in other types of multifamily properties. These offers range from building to building and can include grooming services for pets, offices for business meetings, fully equipped gyms, rooftop bars and lounges.
For high-rises located adjacent to bodies of water, marina slips, maintenance, and winterizing services for boats are also offered as additional incentives to attract residents.
Beyond the extreme luxury, high-end high-rise buildings have staff on hand to help residents with everyday needs like transporting groceries or oversized deliveries like furniture.
Plex apartments are often seen as a starting point for new real estate investors to take ideas and put them into action. The investment costs are low (comparatively), and there can be tax incentives that allow residents to live in a property while improving it for notable tax savings.
Senior housing is a subsector of multifamily that will see unheard-of levels of growth in the following decades; demographics clearly detail the coming need and the timeline for providing it. This asset type will soon offer a variety of in-demand products for an underserved market.
Historically, this asset type had fallen through the cracks of many real estate investors’ interests as it was a cost- and labor-intensive effort to build, run, and maintain these facilities. Unlike traditional multifamily or hospitality assets, the needs of senior housing’s clientele change as time passes.
This situation has traditionally given senior housing facilities two bad options to choose from:
It is said that necessity is the mother of invention, and the coming wave of baby boomers requiring senior housing has innovative real estate developers quickly putting together new comprehensive strategies to meet the challenges that senior housing has historically posed.
Instead of senior housing that targets a particular sub-demographic of seniors and then struggles with what to do when they age out of that targeted demographic, new developments will focus on providing care models that work with residents for their changing needs as they age.
These models are also concentrated on economically sound land acquisition, partnerships with healthcare providers, and innovative implementation of technology to create an attractive business model for investors that delivers healthy profits and unmatched health outcomes for residents.
Similar to other healthcare sector, MOB is a recession and eCommerce resistant real estate asset class. Medical attention and visits to doctors offices are never likely to go away even with the increasing usage of telemedicine to diagnose and treat minor ailments. Industry experts predict that the further expansion of telemedicine options will lead to increased usage of these services, with a related increase in office visits as a result.
MOB’s typically have high credit tenants (physicians) who make considerable investments in their facilities making it difficult for them to relocate. Most practices build considerable patient bases in the immediate proximity of their offices which further make them ‘sticky,’ high credit tenants that tend to stay in place for long periods of time.
The asset class is broken up into various types of MOB, from large ‘on campus’ buildings associated with hospitals, to buildings in close vicinity to hospitals, to isolated buildings in sub-urban, residential or retail areas.
Here are Alliance, we focus on the single or multi-tenant, sub-urban MOB type real estate, where we acquire the building from existing owners who are typically the current tenant, and then lease back to them, releasing capital to them and taking the burden of managing the real estate from them.
Want to learn more about our investment management and process? Talk to one of our experienced advisors.
Industrial assets are work-horses of the real estate world as they quietly turn profits with little to no fan-fare. Long lease terms, low turnover, and even lower maintenance requirements make these properties incredibly simple to underwrite and generate a steady cash flow.
While warehouse space is required in many locations, these properties are more highly concentrated in areas surrounding ports, airports, and major interstate points. This asset type is unlikely to produce outlandish returns but is a solid addition to any portfolio looking to diversify.
Smaller flex warehouses are usually found embedded in communities and are used by the building supply sector like lumber, plumbing, and metal supply companies. These sometimes serve as transit points for eventual deliveries to community building supply companies.
Lastly, cold storage warehouses are a type of industrial asset that can be quite lucrative but require far higher maintenance expenditures than average warehouse assets.
Manufacturing assets share the benefit of most industrial assets of low turnover and long lease terms. However, refitting a property when there is a changeover in tenants can be extremely costly and could take substantial time to recoup the CapEx required to attract a new lessee.
Conversely, failing to provide a potential tenant with the refitting they require can often result in manufacturing properties that stay vacant for months and even years at a time. It’s sometimes possible to subdivide the property and rent a portion of the space, but this might still result in a net loss for the property owner.
Since the rise of the internet and Amazon, retail real estate has struggled. That said, All prosperous towns and cities aggressively market their robust selection of bars, restaurants, and other retail offerings as the factor that defines the character and personality of their area.
Retail isn’t dead; it is just finding its new footing in response to the sudden increase in digital sales.
Malls have unquestionably declined in value and attractiveness to investors, but with so many properties, massive square footage, and locations frequently adjacent to significant state and national transportation arteries, there is unquestionably redevelopment in malls’ future.
Much of the value of these properties will depend on the level of investment cities and developers are willing to put into the planning process. Simply knocking down what used to be a Macy’s and putting up cookie-cutter multifamily structures is not a recipe for success.
Multiuse properties that mix retail with multifamily and public spaces like parks and athletic areas will be far more attractive to both residents and potential retail lessees.
The depth of redevelopment plans is something that investors should look into thoroughly before deciding which mall redevelopments are worth the money and which are a bust.
Community retail is a catch-all term that covers the variety of businesses found in communities across the country. Included in (but not limited to) this category is:
Community retail can either look like traditional small-town America or strip and mini-malls. Many strip malls have replaced the failing mall districts and often feature a big-box retailer that supports lesser-known national brands and local stores on its flanks.
Finally, special-purpose properties, properties that don’t neatly fit into any category include (but again, not limited to) in this category is:
Regardless of the asset type, class, or market, commercial real estate provides economic opportunities for investors of all types. Even in periods of economic turmoil, businesses need physical locations to manufacture, store, sell, and provide whatever product or service they’re involved with.
Anyone predicting the end of this asset type or that asset class simply has failed to imagine what a city, market, or even small town would look like without such assets.
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