Main segments of the commercial real estate market

Main segments of the commercial real estate market

Of course, the basis of the foundations is land or a land bank. It is land that defines real estate as an asset that will be sold. So far, even the most innovative technologies do not allow the transfer of land.

The key parameters of a land plot that determine the possibility and profitability of its further use are the location, physical characteristics, permitted use and building parameters.

By definition, land assets are the riskiest investments. The key investment risks of land assets are high uncertainty in meeting the deadlines and implementation parameters for planned projects.
Next, let’s talk about the main market segment – commercial real estate.

Commercial real estate accumulates most of the investment assets in both the B2B (business to business) and B2C (business to client) segments.

Traditionally, the largest investment segment is the office segment. Namely, buildings for the offices of companies. Why?

First, it is universality and volume of demand. Everyone needs offices, from the giants of the world economy to small entrepreneurs. Secondly, guaranteed cash flow through long-term and non-cancellable lease agreements.

Both investors and tenants themselves are usually interested in long-term leases. Lease agreements are usually concluded for a minimum of five years. And in mature markets such as London, there are precedents for contracts even for an eighty-year period. Thirdly, there is potential for growth in value for office assets.

The growth in value over the life cycle of an asset is determined by the opportunity to increase the rental rate, as well as by the increase in demand for quality assets.

Retail or currently more precisely defined retail and leisure property is also the largest segment of the investment property market. The demand for rent here is formed by retail operators, and operators in the entertainment sector such as cinemas, clubs, restaurants (mainly chains). The specificity of these assets is the large segmentation of tenants. Large anchor tenants such as super and hypermarkets, cinema chains and food service chains occupy large areas on long and inextensible leases at low rates. Typically, the terms of such contracts vary from 10-15 years or more.

Medium and small tenants occupy most of the asset at much higher rates but for shorter periods. This combination means higher volatility in investor returns, which is reflected in the valuation.

Warehouse property. One of the largest and most dynamic commercial real estate segments. The dynamics of this segment depends, firstly, on the specifics of demand.

Renting or owning warehouses is an area of ​​interest for large manufacturers, logistics companies and retail chains. These companies quickly respond to changes in the macroeconomic situation. Secondly, the design and construction of warehouses takes much less time than buildings of other functional purposes. That is why warehouse real estate reacts faster than other segments to changes in supply and demand in the economy. The specifics of the buildings and the tenants’ requirements for them determine a longer term for the lease of buildings (from 10-15 years or more).

The risks of investing in this segment are a lower potential for growth in value and a high specialization of buildings.

Hotels. Another key market segment. More complex both due to the complexity of operational management and demand dynamics. Hotels are usually managed by large chains on the basis of long-term lease agreements with investors. Demand for hotel services is usually provided mainly by private rather than corporate clients.

Since hotel customers are ordinary people, the demand and, accordingly, the profitability of the hotel business instantly reacts to the state of the economy. This volatility is reflected in the valuation.

Residential real estate. The largest segment of the market. It is usually the subject of investment by private investors, both taking into account the specifics of the assets, and taking into account the rather low profitability.

Recently, taking into account the rising cost of real estate around the world and, accordingly, the inaccessibility of housing for a sufficiently large number of people, the popularity of the so-called tenement houses is growing. Profitable houses are residential buildings that are built at the expense of investors. And by analogy with offices, they are leased by operators to private individuals in order to obtain a guaranteed profitability.

Examples of such houses (although rare), but there are in Russia. In mature markets, this segment has been around for a long time. And its popularity in recent years