Commercial real estate is fundamentally any property that’s used for business, so it is one of the broadest categories for investing. There are five types of commercial real estate, and each has its own unique niche in the investment marketplace. Even within the five categories residential, office, flex, retail, and hospitality are several subgroups. Before you get into commercial investing, knowing the basic types of property and the fundamentals of commercial leases and tax benefits is critical if you are going to succeed. Here, we’ll discuss the different types of commercial real estate.
For many commercial investors, multifamily properties are an attractive entry point. While there are many different kinds of multifamily housing from garden apartment complexes to high-rise buildings, even student housing all gather under the multifamily umbrella they all have one thing in common: multiple tenants driving multiple income streams.
This matters because when you have more than one tenant, a vacancy isn’t a deal-breaker. Banks and other lenders don’t look at multifamily properties as high-risk propositions like they do single-tenant properties so financed apartments typically carry lower interest rates. The economics of real estate investing are to leverage assets to purchase additional assets. Multifamily properties are extremely scalable the cash flow grows faster and you can reinvest your profits more quickly, and in bigger projects.
The tax benefits of multifamily investments give you the best of both worlds depreciation and cost-segregation tax breaks as the building and fixtures age, even as the actual value of the building increases.
Another type of commercial real estate, office space, is slightly more sophisticated in terms of tax benefits and lease structures. Cash flow is certainly important, but these other two factors are equally important to investors.
Standard office leases run for five to 10 years. Long-term leases provide more of a bond-like return; in exchange for a multi-year lease, tenants pay a lower rent. The upside is that moving an office is expensive, so tenants are more likely to renew a lease than look for new space.
Lease structures are also attractive to investors. Building management can offer gross, modified gross, or triple net leases to tenants, depending on the owner’s goals. For example, a lease may be written that passes all the building’s operating expenses to the tenants, providing an inflation hedge for the owners. Annual base increases are also built into most multi-year leases, so investors see additional annual revenue increases.
Tax Advantages of Office Buildings
The IRS allows a commercial building to depreciate over 39 years, which creates a long-term tax shelter for investors. Depreciation is dependent on the percentage of a building an investor owns, but once you have two or three office investments, it is a healthy tax benefit.
The latest type of commercial investment is the flex, or hybrid, model. Flexible property-a mix of office and industrial space is the jack of all trades in real estate. Flex buildings can either be stand-alone building available for any kind of use or be located in densely packed industrial parks.
A typical flex building has office space in the front, and storage, manufacturing, or warehouse or all three space in the back. Flex spaces are also cheaper than Class A-B buildings, giving the tenants the square footage they need at a reasonable cost. The customization of the space makes it highly attractive when tenants are sensitive to shared spaces the single-story layout allows each tenant their own private entrance.
These are some typical flex space tenants:
- Office/warehouse/craft brewery
- Coffee shop/storage facility/gym/restaurant
Flex spaces also bring in a broad variety of tenants, unlike Class A-B space that caters to a white-collar workforce. The ability to build out space to suit a wide mix of tenants also gives investors a hedge against dos in a given industry.
Finally, most flex spaces are triple-net leased. Owners pass the hard costs of operations insurance, taxes, and common area maintenance to the tenants.
Retail space is another type of commercial real estate. Retail partnerships are popular investments because they provide a steady income stream and capital appreciation. Although there were concerns during the pandemic that retail recovery would be slow, foot traffic in most parts of the country is strong. Retail assets range from high-end suburban shopping centers to fast food outlets at interstate interchanges, so the options for investing in retail are tremendous. Like office space, retail tenants sign multi-year triple net leases and have a great financial incentives not to move.
Hotels, restaurants, entertainment venues, and other experience-driven businesses are the most volatile of commercial investments. These businesses exist solely for travel and entertainment, so investors in hospitality need to be prepared for lean times during recessions and pandemics. Hospitality entities are similar to office space in that there are classes of hotels and restaurants–high-end luxury resorts, medium-priced chains, and budget hotels and fast-food restaurants. Unlike offices, these businesses are both real estate and operating companies, so owners structure leases with a percentage of net sales included in the lease.
Limited Partnerships Offer Unlimited Opportunity
It’s all very intriguing, isn’t it? The advantage of investing with EXtrance is that we offer a broad range of limited partnerships, so you can begin investing with modest amounts of capital, then scale up your stake into several different partnerships as your cash flow grows. Our partners are vetted before they are allowed to invest in our partnership opportunities, so you have confidence in knowing you are dealing with serious investors. Contact us today!