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Commercial real estate is one of the three main types of real estate, along with residential and industrial. As its name implies, commercial real estate is used in commerce (residential real estate is used for living purposes, while industrial real estate is used for the manufacture and production of goods). While some businesses own the building they occupy, the more typical scenario is that an investor owns the building and collects rent from each business that operates there. While residential real estate lease-rate may be quoted in an annual sum or a monthly rent, commercial real estate is customarily quoted in annual rental dollars per square foot.
Types of Commercial property lease
There are four primary types of commercial property lease, each requiring different levels of responsibility from the landlord and the tenant.
A single-net (N) lease makes the tenant responsible for paying property taxes.
A double-net (NN) lease makes the tenant responsible for paying property taxes and insurance.
A triple-net (NNN) lease makes the tenant responsible for paying property taxes, insurance, and maintenance.
Absolute triple-net, this type of lease is often referred to as a bond-able lease or a hell or high-water lease, meaning that the tenant is responsible for all the expenses and repairs relating to the building including the roof and structure.
Under a gross lease, the tenant pays only rent, and the landlord pays for the building's property taxes, insurance, and maintenance.
Commercial Real Estate Classifications
Commercial real estate is categorized into different classes. Office space, for example, is divided into one of three classes: class A, class B or class C.
Class A represents the best buildings in terms of aesthetics, age, quality of infrastructure and location.
Class B buildings are usually older and not as competitive price-wise as Class A buildings. These buildings are often targeted by investors for restoration.
Class C buildings are the oldest, usually over 20 years of age, located in less attractive areas and in need of maintenance.
Investing in Commercial Real Estate
Investing in commercial real estate can be lucrative and serve as a good hedge against the volatility of the stock market. Investors can make money via appreciation when they sell, but most returns are generated through rents collected from tenants.
In most cases, properties are sold by the building — one office building, one restaurant, one factory, etc. However, if a developer wants more capital to expand a project or wishes to see the returns more quickly, the project will be broken down into smaller units rather than sold.
Advantages of Commercial Real Estate
One of the biggest advantages of commercial real estate is the attractive leasing rates. In areas where the amount of new construction is either limited by land or law, commercial real estate can have impressive returns and considerable monthly cash flow.
Industrial buildings generally rent at a lower rate, though they also have lower overhead costs compared to an office tower.
Commercial real estate also benefits from comparably longer lease contracts with tenants than residential real estate. This gives the commercial real estate holder a considerable amount of cash flow stability, if the building is occupied by long-term tenants.