Commercial real estate is property used solely for business purposes. Office buildings, malls, industrial parks, hotels, convenience stores, apartment complexes and gas stations are all examples of commercial real estate.
Commercial real estate is distinct from residential real estate, which has been under the microscope in 2007 and 2008 due to the subprime lending crisis. Issues related to the failure of mortgage-backed securities have driven property values down and created problems for both home owners and institutional lenders, and this has had a rippling effect on other parts of the economy. The commercial real estate market has suffered from the fall-out, but it has not bled as deeply as its residential cousin.
These companies depend on the relative strength of the commercial real estate market to earn new contracts, as well as the continued financing of their current projects by existing developers.
Real estate investment trusts, or REITS, are corporations or trusts that pool the capital of many investors to purchase income property (equity REIT) and/or mortgage loans (mortgage REIT). An equity REIT owns and manages property, as opposed to a mortgage REIT which purchases mortgages and may also borrow money from banks to lend again at higher interest rates. REITs that invest in commercial real estate can do so through commercial loans, or through the development and ownership of property. Shares in a REIT are publicly traded on stock exchanges, and these companies are eligible for corporate income tax exemptions but in return are required to distribute 90% of their income to shareholders as dividends.
REITs are exposed to the volatility of the commercial real estate market in that their revenues will decline if rents and property values are low, or if costs of development or borrowed capital are too high. However, most REITs have diverse portfolios with holdings in a variety of economic sectors and geographic regions, helping them to shield them from isolated fluctuations in the market. Below is a list of commercial REITs, broken down by the sector on which they focus.
These REITs focus on the development and/or ownership of office buildings.
These REITs focus on the development and/or ownership of hotel properties.
These REITs focus on the development and/or ownership of industrial complexes.
These REITs focus on the development and/or ownership of properties that serve the retail sector.
These companies develop commercial properties and sell them to investors. They depend on the health of the market to maintain properties above development costs, so that their business is profitable. Most commercial real estate development is financed by large Real Estate Investment Trusts (REITs, see below How To Invest in Commercial Real Estate), so firms in this category are smaller in scale.
There are two basic ways to invest in commercial real estate:
Direct investment in Commercial Property offers a number of unique advantages to the investor.
Indirect investment in real estate means purchasing shares of publicly listed and traded REITs - pooled properties and/or mortgages bundled together and offered as a security. Indirect investment, through REITs, also offers advantages:
The U.S. Housing Market has been hit hard by issues in the financial market created by the subprime lending crisis. In summary: inflated confidence in housing prices led lenders to give mortgages to unqualified buyers, which led to spectacular short-term gains, and they packaged these "subprime" loans into groups (called collateralized debt obligations) that were traded like securities and purchased by some of the largest investment houses like Citigroup (C) and Merrill Lynch (MER). But when booming housing prices started coming down, borrowers started defaulting on the loans that they never should have qualified for in the first place, and the banks had to write down the value of their mortgage-backed assets. This created huge losses for banks in 4th quarter 2007, and also restricted their ability to borrow and lend capital, creating a credit crunch that has spread into other parts of the economy, restricting consumer spending and creating chaos in the markets for certain types of securities.
But even as the residential housing market bottomed out, commercial real estate seemed to stay above the fray, and prices stayed high. Why didn't the subprime crisis, which had such sweeping effects on seeming unrelated parts of the economy, bring down its first cousin commercial property?
Over the past several years, developers completed new buildings at an aggressive pace. 75 million square feet of office space scheduled for completion in 2008, an increase from 53 million square feet built in 2007. However, as economic growth slowed throughout late 2007 and into early 2008, demand for office space remained insufficient in most markets to absorb this new development. For example, the national office vacancy rate increased from 12.5% to 12.6%. Nevertheless, rents and occupancy rates continued to increase over the same time period in the highly competitive markets of New York City, Boston, Houston, and Denver.
So although office landlords haven't dropped rent prices, they will have to find ways to retain customers and attract new ones in an increasingly competitive market. Many firms have started offering more concessions to clients, such as interior construction work and months of free rent. Effective rents, which take into account concessions such as a free month's rent upon signing a lease, were flat or falling in 16 markets in the fourth quarter of 2007, compared with seven markets in the third quarter.
Rent revenues and cash flow from commercial properties is therefore steady, but commercial assets are falling in value. This is primarily because institutions have raised standards and slowed their lending pace, and it is becoming more and more costly to finance the acquisition of commercial properties. Many owners borrowed aggressively from 2005 to 2007, before the residential housing slump, and these borrowers will need to refinance their loans soon. Some won't be able to borrow as much or get the same terms, which puts them at risk of default. Others, however, have seven- or even ten-year terms on their loans, and this time-frame offers ample opportunity for the financial industry to resolve its issues and for the market to rebound.