The COVID-19 pandemic has changed the world of commercial real estate, possibly for good. While it is clear how the rise of remote work has affected office buildings, it has also affected every other category of commercial real estate - including retail, industrial, hotel/hospitality and multi-family residential. Although the pandemic isn’t over yet, it has entered a new phase which has seen workers return to offices and the values of commercial real estate have begun to recover. While remote work is likely here to stay, in-person work is not going to disappear completely, and the world of commercial real estate will have to adjust.
Commercial real estate is a catch-all term for properties that are used for business activities. Similar to residential real estate, it offers both potential cash flow and appreciation, though it tilts further towards cash flow. The idea is that rental income from tenants produces a predictable and steady cash flow, while the underlying asset grows in value. Commercial real estate tends to have significantly longer leases than residential real estate, and as such, it is generally considered a more stable investment. However, because there is a lower chance of rapid appreciation, there is also generally less upside than residential real estate.
While commercial real estate can be organized into any number of categories, commonly it is broken up into five - Office Space, Retail, Industrial, Hotels/Hospitality and Multi-family.
This category encompasses everything from massive skyscrapers in urban centers to office parks in suburban areas to small medical or dental offices to office space in mixed-use buildings. The lease length tends to be anywhere from short-term (month-to-month) to as high as decades for anchor tenants in large office towers. Generally the rent is based upon a price per square foot ($/sqft.) measurement that varies based on location and amenities.
Offices have been the most prominent type of commercial real estate to be affected by the pandemic, with some estimating a permanent decline in demand by 15%. While many large companies have attempted to get workers back to the office, the compromise of hybrid work is likely to lessen the demand for office space going forward.
Retail buildings are another major category of commercial real estate, and consist of all kinds of stores, banks, restaurants, supermarkets, strip malls, shopping centers, and anywhere that people go to purchase goods or services. These properties are often located near or within residential neighborhoods in areas with foot traffic, and can range in size from a corner store to a shopping mall. Lease terms are generally long, with larger, more stable businesses like banks and pharmacies often having decades-long leases. National chains can also often have very long leases into the decades, while local small businesses and restaurants may have shorter leases in the 3-5 year range.
As a whole, retail has struggled during the pandemic, with fewer people doing in-person shopping. Restaurants have particularly been hit hard, but have been rebounding lately, particularly restaurants that emphasize take-out and delivery. Retail is such a large and varied category that some subcategories have performed well, for example, grocery stores and drug stores have held up during the pandemic and are expected to continue doing so.
Industrial real estate includes any land and buildings that support or enable research, production, warehousing, storage, and distribution of goods. The types of buildings include warehouses, storage facilities, factories, distribution centers and data centers, among others. Almost every product in your household has, at some point, been a part of the complex process of research, development, production, warehousing, and shipping before it made its way to your home. Any real estate involved in that process is technically industrial real estate.
Industrial real estate often provides higher cash flows than other commercial real estate subcategories, as the potential for appreciation is often lower. They are usually built on cheaper and less desirable land outside of cities because of the large footprints of the buildings. Most industrial real estate is leased to a single tenant on a long-term lease and provides stable cash flow. The value of the building is usually tied to the amount of rent that can be charged.
The pandemic accelerated the growth of e-commerce, and with that, the value of warehouses, distribution centers and specialized storage facilities rose. Warehouses in particular saw rising demand - by some estimates, by 2025 the U.S. will need extra 330 million square feet of warehouse space just for online fulfillment. On the whole, industrial was one of the best performing sectors in real estate over the past few years.
This category includes hotels, resorts, wellness centers, golf courses and amusement parks. Many of these have struggled during the pandemic and while travel and tourism has increased, it may take years for hotels and resorts to recover to pre-pandemic levels. This is a category that is generally still not too accessible to fractional or crowdfunding investors and is usually the purview of large corporations or developers.
Commercial multifamily properties are those with 5 or more apartments or mixed-use buildings with both residential and commercial units. Though they are considered commercial real estate, they have more in common with residential real estate than the rest of the categories here. As such, they were discussed at length in the residential real estate investing guide. They tended to perform better than other types of commercial real estate during the pandemic, thanks in part to the stimulus checks helping people stay current on their rent. Additionally, the rise of remote work actually benefited upscale residential properties, as people are now spending more time at home and want nicer surroundings.
Investing in commercial real estate is a longer-term play that usually does not offer much opportunity for liquidity. It is best suited for patient investors who can afford to tie up capital and potentially sacrifice short-term gains for longer-term returns. Traditionally, in order to invest in any kind of commercial real estate, an investor needs to have capital for the down payment or be a part of a real estate syndication. That can often be a high barrier to entry, but with Vincent, investors can get access to many different types of commercial real estate investments at a significantly lower entry price.