If you’re looking to diversify your existing commercial real estate portfolio, determining which property type to add can feel daunting.
CRE comes in different shapes and forms. From the ubiquitous shopping malls and office blocks, to the more obscure self-storage and data centers, there’s a type for every investor, to be sure. But which is the best choice for your investment goals, and why? And where should you invest to get the best returns?
We answer all those questions, and more, in this guide. You’ll learn about the three most prevalent commercial property investment types: offices, retail, and industrial. We cover the pros and cons of investing in each type, offering you tips on how to build a diversified CRE portfolio. Read on.
Commercial Property Types In-Depth
Offices
Multi-tenanted office parks, blocks, and single-tenanted spaces can be a highly profitable inclusion to any CRE portfolio.
A great advantage of office spaces is that leases are typically long, sometimes extending up to 10 years. This ensures income stability.
Office locations in prime areas tend to appreciate over time and maintain low vacancy rates thanks to less tenant turnover compared to retail spaces. However, offices require regular refurbishment to remain appealing to top-tier tenants, meaning investors need to be prepared for significant intermittent expenditures.
Trends in Office Spaces
Despite the shifts towards remote work due to the pandemic, quality office spaces in key locations continue to demand attention. The biggest challenge has been an increase in remote work which has added uncertainty to the market.
As businesses shift to a hybrid working model, the demand for office space that caters to flexible work solutions will grow in the coming years. On the other hand, remote work trends have resulted in a decrease in the demand for traditional, pre-pandemic type of office spaces.
One thing is certain: quality office space in key areas remains desirable.
As a CRE investor, these market shifts mean you will need to adjust your strategy. You’ll be looking for newer, more sustainable office buildings to add to your portfolio. As a broker or developer, you might find some great deals in older building stock that needs renovating into more flexible workspaces – the kind that accommodates hybrid working.
It seems that the golden ticket lies in the middle ground: adaptable spaces near amenities that can cater for changing workplace needs.
Pros
- Long leases
- High capital appreciation in prime locations
- Low tenant turnover
Cons
- Regular refurbishment costs
- Keeping up with changing workplace trends
- Operating costs can be higher due to utilities and maintenance
Retail
From large shopping malls to the local corner convenience store, the retail realm is vast. Retail can be a highly profitable CRE venture balanced out by the volatility of constantly shifting consumer habits and economic cycles. It’s as exciting as it is unpredictable, but with the right strategy can offer big rewards.
Trends in Retail
While the rise of e-commerce has shifted some consumer behaviors, physical retail spaces with heavy foot traffic and a diverse tenant lineup still provide a source of steady income. The right balance between online and physical presence is needed to maximize retail potential.
The pandemic has reinforced the importance of flexibility and adaptability in retail spaces. Properties that offer experiences beyond simple shopping—such as dining and entertainment options—remain successful.
Mixed-use spaces are a rising trend in retail. Mixed-used developments offer more income stability for property owners due the diversity of tenants and consistent use of the property at all hours of the day. Consider, for example, the potential of a multilevel property of which the lower levels are a shopping mall with restaurants, clothing shops, a pharmacy, and a department store. The upper levels house office space or even residential apartments, depending on how many levels there are. You are essentially creating your own foot traffic to your retail space.
CRE developers can capitalize on this trend too, by redeveloping existing shopping complexes to allow for more mixed use.
Pros
- Highly profitable with the right strategy
- Spaces with high foot traffic and diverse tenant mix provide steady income
Cons
- Higher tenant turnover than offices
- Refurbishment costs
- Requires an agile approach to the constantly changing retail market
- E-commerce impacting demand for physical retail spaces
Industrial
Industrial real estate can include a range of building types such as factories, warehouses, distribution centers, and more.
This stable sector of CRE offers long-leases and minimal input from a CRE investor as most industrial buildings are tenanted using triple-net-leases (where the tenant is responsible for maintenance and upkeep).
Location plays a key role in the success of industrial properties, since the proximity to major transportation routes is crucial for logistics. For developers, finding suitable land for industrial buildings can be challenging and development costs can be high.
The rise in e-commerce has resulted in an increased demand for warehouse and distribution centers over the last few years. There are several upsides to focusing your efforts on warehouses, based on the upwards trend in online shopping:
- The high demand from e-commerce giants drives rent growth and occupancy.
- Warehouses offer lower tenant turnover and vacancy risk compared to other sectors in CRE, making them recession resistant.
- Warehouses have been appreciating in value due to limited supply.
Trends in Industrial
In terms of the market, the e-commerce boom has spiked demand for modern, well-located warehouses. The trend towards automation and sustainable building practices is worth noting, as these features can attract tenants desiring modern, efficient, and responsible operations, potentially leading to higher rents and lower turnover.
Pros
- Long-term leases (often triple-net)
- Lower tenant turnover and vacancy risk
- High demand from e-commerce
- Strong rental growth
Cons
- Limited supply
- High development costs
- Finding suitable land
- Functional obsolescence risk for older properties
Building a Diversified Commercial Property Investment Portfolio
Since office, retail, and industrial property each have distinct advantages along with disadvantages, the best way to build a balanced CRE portfolio is to include a selection of each type. Diversification offers more stability to investors as fluctuations in one market are usually offset by stability in another over the long term.
Here are some tips to help you navigate the process of diversifying your CRE portfolio:
Assess your Risk Tolerance
Before diversifying your CRE investments, it’s crucial to assess your financial goals and risk tolerance. Are you seeking steady, reliable income, or are you more inclined towards opportunities with potentially higher returns but also higher risks?
Here's how you can align your investment choices with your risk profile:
Conservative Investors
If stability and lower risk are your priorities, focus on properties with long-term, stable leases and proven cash flows. Examples include well-established office buildings, industrial properties near major transportation hubs, and retail spaces in prime locations with high foot traffic.
Moderate-Risk Investors
Those comfortable with moderate risks might consider properties that offer a blend of income and growth potential. These could include office buildings with modern amenities that attract high-quality tenants or mixed-use developments that combine retail, residential, and office spaces.
Aggressive Investors
If you are open to taking on more risk for the possibility of higher returns, look towards emerging market areas or redevelopment projects that can transform underperforming properties into profitable ventures.
Understanding your risk tolerance will help you to align with the property type that suits your investment strategy.
Analyze Market Trends
Building a diverse portfolio requires staying informed about market trends and adjusting your investment strategy as needed. This includes understanding how economic, geopolitical, and social factors influence the CRE landscape.
For example, in the office sector more companies are shifting towards a hybrid working model which is changing the demand for traditional office spaces. A savvy investor can lower their risk by including types of office buildings that meet the new market demand in their portfolio.
Examples include:
- A new office space with flexible layouts
- A multi-tenanted office building in a prime area
- A co-working space
- A new office building with energy and water-efficient features
Ask Experts for Advice
Building a rock-solid portfolio benefits significantly from expert insights. Consulting with an experienced broker, REIT (real estate investment trust) manager, or market analyst can provide a valuable perspective.
- Brokers can offer up-to-the-minute data on which properties are performing well and why.
- REITs can offer a hands-off way to invest in diverse property types while benefiting from professional management.
- CRE Market Analysts can help you understand broader trends that might affect your investments.
Leverage CRE Technological Tools
Advanced geographic information systems (GIS) location insights tools are a suitable place to start with market research and trends analysis. These tools can help you identify potential investment opportunities and assess the suitability of various locations based on detailed demographic and economic data. You can use GIS platforms to study and analyze:
Find a Tool Specific to CRE
Perhaps you’re already using a GIS analytics tool but it’s missing the nuances specific to the CRE sector. You could choose a CRE-specific location insights platform, like AlphaMap. Its user-friendly interface has been designed to look and feel like Google Maps – only much more powerful.
Revisit and Adjust Your Portfolio
The CRE market is not static, and neither should your investments be. A well-diversified CRE portfolio requires regular assessment and realignment in response to market changes and personal investment goals. Periodically reviewing your portfolio’s performance with your broker will ensure the properties in your portfolio continue to meet your investment goals.
Final Thoughts on Commercial Property Investment Types
Today’s CRE investor needs to remain adaptable. Don't just diversify your portfolio blindly - really understand the unique dynamics driving each sector. Get savvy on things like hybrid work models impacting offices, the experience-driven future of successful retail, and the e-commerce-fueled boom in industrial warehousing.
The most lucrative deals often come from boldly redeveloping spaces in innovative ways – such as turning an old mall into a mixed-use marketplace merging retail, dining, offices, and apartments. With the right data-driven location analysis tools, like AlphaMap, you can get creative while managing risks.
Diversity builds a strong portfolio, but intentionality will maximize your returns. By engaging deeply with the market, consulting with seasoned experts, and making use of advanced analytics you position yourself not just to respond to the market, but to shape it.
Best of luck with your investment journey!
