What are the fundamentals of CRE?

There is often the lure of investing in commercial real estate, but that can be without much knowledge about what makes the industry tick, so let us take a look at the fundamentals of CRE.

What is necessary to begin with CRE?

Commercial real estate is an entirely different world of wealth and prestige. The road to that outcome is filled with opportunity and risk. It’s possible to create a CRE portfolio of properties providing cash flow to build even more which is how those lofty dreams of empires are created.

On the flip side, it is also possible to be caught by a change in market conditions leading to serious business and personal losses.

Building or investing in CRE requires the developer or investor to understand what is known, be aware that there are unknowns, and be prepared for those unknowns . This means understanding what is expected to happen, what is expected but its timing or cost are unknown, and being prepared for something completely unexpected at any point in the timeline. The process requires knowledge, awareness, and strategic planning.

What is Commercial Real Estate?

“Commercial real estate is mislabeled,” said Lynn McKee, director of the Masters of Science  Commercial Real Estate program at Georgia State University. “It always has been because when people hear ‘commercial,’ they think of office buildings and shopping centers. It really should be called ‘income-producing real estate’. This is due to the wide array of scenarios that involve

McKee broadens the definition, saying that even single-family residential development is “commercial real estate” because its purpose is to generate revenue or a revenue stream for the developer.

What are the types of Commercial Real Estate?

There are many silos or sectors in the commercial real estate field. Real estate investment broker Agora defines that there are eight umbrella categories:

• Office space
• Retail
• Industrial
• Multifamily
• Hospitality and Lodging
• Healthcare and Medical
• Special Purpose
• Land

There are many subcategories under those eight. Some subcategories indicate the quality of a CRE property in terms of amenities, materials and location.

Office space, for example, falls into classes A, B and C. Recently, some brokers have been promoting Class A+ or AA. Industrial space can include manufacturing and warehousing. Office space has corporate, shared workspace and medical office buildings as options.

How does CRE differ from residential real estate?

Residential is commercial real estate using the McKee perspective, but for the record, others will consider only multifamily residential as commercial.

“It’s still all income-producing real estate, he said. “It’s the scale you’re doing it at. It’s the capital involved. It’s the expertise that it takes. It’s all those other factors, but it’s still basically the same thing (as a commercial project).”

“If someone comes from residential development, they come from a different path, but that typically is people who want to transition in on the GC side into commercial, come from a residential path,” said Kolby Smith, director of development for Holualoa Companies. “Every asset class has nuances and building codes, and you really need to be familiar with what you’re getting into because things may appear much more simplistic than they are.”

Smith likes to give examples of times he’s heard people comment about industrial buildings being very easy to build. 

“The level of precision required in that (industrial) building is leaps and bounds more than what you’ll see in residential or even multifamily,” Smith said. “Not underestimating that and not overestimating your capabilities because you’ve done X number of multifamily. It’s not the case there. There’s a lot of nuance to all of these things that you see (from) a lot of builders as market cycles move.”

He said many developers try to navigate from one asset class to another without understanding the learning curve. He cautions that even established organizations that have been around for an extended period often must bring in outside help.

What are the key terms in CRE?

NAIOP, the national trade association for commercial real estate professionals, compiled a comprehensive glossary in 2024. “Commercial Real Estate Terms and Definitions,” a 51-page comprehensive source for learning the language, covers many aspects of CRE terminology by dividing it into sections starting with Building Status Definitions and covering types of development, measurement, and sector-specific definitions.

How to Invest in Commercial Real Estate

There are two ways to invest in CRE: as an active developer or as a commercial lender/investor. For the investor providing money, there are great opportunities, but also significant risks.

The most straightforward investment model is to provide the capital for a project. This “all eggs in one basket” approach comes with risk offset by due diligence and market analysis to determine whether the project can succeed. It’s often known as “hard money” or private lending and carries a higher interest rate, a definite end date, and a greater risk.

“The loans are less reliant on the borrower’s creditworthiness. Some form of security usually backs hard money loans,” said Gordon Lamphere, vice president of Von Vissinger & Co. “You need to get into hard money lending with a good attorney at your side. Private lending is heavily regulated, and it’s imperative for the borrower to have legal advice and apply through a broker.”

The real estate investment trust, better known as a “REIT,” provides a higher level of security.

“(REITs) allow smaller investors to participate in large real estate projects,” said Howard Krieger, managing director of Reitreal. “When you think of skyscrapers, they can cost hundreds of millions (of dollars). Some (business) campuses can cost up to a billion. The REIT was conceived as a way to sort of fractionalize and break up (the cost) and democratize investment into it.”

What is the importance of CRE in the global economy?

The world of commercial real estate centers around the U.S. economy. Clarion Partners estimates the CRE universe – all marketable commercial real estate properties – to total almost $27 trillion as of October 2024.

Canada, Germany, China, Japan and Singapore are the top countries from which foreign CRE investment originates. According to Luke Dawson, head of Global and EMEA Capital Markets for Colliers, in “Colliers 2025 Global Investment Outlook,” the trend for 2025 is expected to continue upward.

It’s more than capital inflow and outflow. Leslie Shen, an economist with the Federal Reserve Bank of Boston, included in a 2023 report for the Bank, “…foreign real estate capital can really influence local employment and potentially affect welfare. I think it’s important to highlight this kind of under-documented, underappreciated component of international capital flows that can really have domestic impacts.”

What professionals are crucial for CRE?

Most experienced CRE developers say that entering commercial real estate is a “do not try this at home” effort and outside expertise is critical.

Smith says that building the team is essential even before getting financing. McKee says that a developer cannot know it all. He describes the developer as the performer spinning multiple plates on poles, keeping them all in play.

McKee and Smith both call out these same basic team members as being a critical part of a successful project:

• Project Manager: Acts as an orchestra conductor managing milestones, tasks, budget and timeline. The PM is the developer’s representative throughout the project.
• Architect and Land Planner: Create the design, understand the zoning regulations and put a concept on paper.
• Land Use or Zoning Attorney: Navigates the required permitting process. It may be as simple as an entitlement to develop and a building permit to start construction or as complex as needing additional permits from special districts, counties, state agencies or the federal government.
• General Contractor: Hires the trades and subcontractors necessary to build the project. Has the experience to know how to build within budget constraints.
• Civil Engineer: Designs the infrastructure and utilities and works with the local government on off-site improvements needed for the project.
• Broker: Ensures that the project contains the design, material and amenities necessary to command the correct leasing rates or sales price.
• Marketing and Public Relations: Puts the project into play and manages public interest. In concert with the broker, it builds anticipation from future tenants or buyers.

Depending on the size and scale of the project, the full team may also include a landscape architect, commercial interior designer, contract project manager, specialty engineer, and others.

Is CRE a do-it-yourself project for the uninitiated?

Steve Betts, managing director of development for the Holualoa Companies, said there are many pitfalls for a beginning CRE developer. He suggests in addition to hiring an experienced team, another option is to pair up with an experienced CRE developer and develop a project.

“You may need to find somebody that’s been in construction or in engineering (because the) level of finish isn’t necessarily the same,” said Betts. “People need to kind of look at that, and (it) is a whole different kettle of fish too…much, much, much more nuanced.