Okay, let's unpack this. Welcome back to another
deep dive. Today, we're tackling something that
is, I mean, it's literally all around us. It
really is. If you're listening to this on your
commute, you're driving past it. If you're sitting
in an office, well, you're sitting inside of
it. If you stopped for coffee this morning, you
just did business in it. It is the backdrop of
our entire lives, quite literally. You could
say it's the stage upon which the entire economy
performs its act. Exactly. we are talking about
commercial property. And I have to be honest,
before looking at these sources, and we have
a stack of them today, I kind of just thought
of it as buildings that aren't houses. Right,
the simple definition. Yeah, skyscrapers, trip
malls, maybe a warehouse here and there. But
when you actually dig into the numbers, the scale
of this industry is just... It's absolutely mind
-boggling. It is staggering. I mean, to give
you a sense of the sheer weight of this asset
class, back in 2018, the total value of commercial
property just in the United States was estimated
at approximately $6 trillion. Six trillion. That
is a number that is hard to even visualize. You
can't. It's an abstraction at that point. That's
not just a sector of the economy that is like
the foundation of the economy. It feels like
the bedrock. It is the invisible engine. That's
the best way to think about it. It's not just
bricks and mortar. It is where capital lives.
It creates jobs. It defines the entire layout
of our cities. And as we'll see later, when we
get into the current market data, it is a massive
flashing indicator of economic health. A leading
indicator. One of the biggest. When commercial
real estate catches a cold, the rest of the economy
often gets pneumonia. It's that interconnected.
And that is really our mission for this deep
dive. We want to take you, the listener, from
seeing just buildings to seeing assets. We want
to decode the concrete and the glass. When you
walk past a shop or an apartment block tomorrow,
we don't want you to just see a facade. We want
you to see. The cash flows, the risks, and the
economic signals that are hidden in the architecture.
Precisely. We are moving from the physical world
to the financial world. You have to strip away
the paint and look at the spreadsheet underneath.
That's where the story is. So let's start at
the very beginning. The most basic quotient,
which frankly confused me at first, what actually
counts as commercial property? Is it just anything
that isn't a single family house? Where's the
line? Well, the definition is actually quite
broad, but it centers on one specific thing.
Intent. Intent. Yes. Commercial property, which
is also known as commercial real estate or income
property, is any real estate that is intended
to generate a profit. Okay. Profit. That seems
simple enough. Yeah. But how exactly does a building
generate profit? I mean, it just sits there.
It sits there, but it works for you. The profit
comes from two distinct buckets. First, you have
capital gains. That's the classic buy low, sell
high strategy you see everywhere. Right. You
buy a property. Maybe it's a little rundown or
maybe it's in a neighborhood that's, you know,
up and coming and its value appreciates over
time. Eventually you sell it for more than you
paid for it. Right. That's the appreciation play.
Just like buying a stock and hoping the chart
goes up and to the right. Simple enough. Exactly.
The second source, and this is really the lifeblood
of the industry, is rental income. This is the
cash flow. You own this space and someone else,
a tenant, pays you for the right to use it month
in, month out. Okay, but here is where I got
stuck in the research. Let's say I buy a nice
little house in the suburbs and I rent it out
to a family. I have the intent of making a profit
from the rent. Is my little rental house now
commercial real estate? Well, technically, no.
And this is where we hit the first big aha moment
for a lot of people. There is a very specific
and you could argue somewhat arbitrary line drawn
between residential and commercial, especially
in the eyes of the United States banking system.
OK, unpack that for us, because I see apartment
buildings that are clearly for people to live
in. That's a residential use, but they are owned
by these huge corporations. Correct. It all comes
down to scale. In many U .S. states, residential
property is considered commercial for borrowing
and tax purposes only if it contains more than
a certain number of units. And what's that magic
number? Usually it's anything larger than a fourplex.
Fourplex. So four units. Right. So a single family
home, a duplex with two units, a triplex with
three or a quad with four. All of that is generally
considered residential. You can walk into a bank
and get a standard 30 year fixed mortgage for
it, much like you would for your own home. So
the bank is looking at me, my income, my credit
score to see if I can afford it. Exactly. The
bank looks at your personal income and your credit
score to qualify you. It's viewed as a personal
investment, just on a slightly larger scale.
But if I add one more unit to that building,
if I buy a five unit building. The moment that
building has five units, just one more door,
it enters the world of commercial real estate.
The game completely changes. That is fascinating.
giant mansion with 10 bedrooms is still residential.
But a small kind of ugly brick building with
five little studio apartments is commercial.
In the eyes of the bank and the taxman, yes.
And it changes everything about how you buy and
own it. You can no longer get that 30 year fixed
mortgage. What do you get instead? Now you're
looking at commercial loans. They have shorter
terms, maybe five or 10 years, not 30. They often
have higher interest rates. And crucially, the
bank stops looking at you and starts looking
at the building. What do you mean by that? They
underwrite the property itself. They analyze
the income of the property. Can the rent generated
by those five units cover the mortgage payment,
the taxes, the insurance, and still leave a profit?
So even if I'm a billionaire? Even if you're
a billionaire, if the building itself loses money
every month, a commercial lender might still
say no. It shifts from being a home that you
happen to rent out to being a business that has
to stand on its own two feet. It's about the
scale and the intent. the building has to perform
as an economic entity. Exactly. The regulations
tighten, the scrutiny increases, and the financing
becomes strictly about the math of the asset,
not the wealth of the owner. Okay, so we've established
the definition. It's for profit, and if it's
housing, it has to be big enough, five units
or more to count. Now, the sources we looked
at categorized this massive commercial world
into six specific... buckets. I love this because
it gives us a mental map to organize the chaos
of a city. It does. It organizes the landscape.
It's a taxonomy for the built world. Once you
understand these six buckets, you can look at
any skyline or any suburban sprawl and instantly
categorize what you're seeing. It's like putting
labels on everything. Let's walk through them.
Bucket number one is probably what everyone thinks
of first. office buildings. This is the classic
image of business, right? With a glass tower.
But even within this one bucket, there's a huge
range. You have the single tenant property, maybe
a small brick building on Main Street owned by
a dentist or an insurance agent who uses the
whole thing. Right. The little standalone structure
with the lawyer shingle hanging out front. Exactly.
That is a commercial office asset. And then on
the other end of the spectrum, you have the downtown
skyscrapers. massive multi -tenant towers housing
thousands of workers for dozens of different
companies. One of the fancy names like the Salesforce
Tower or the Bank of America Plaza. Those are
what we call Class A buildings. The shiny glass
towers with the marble lobbies and the high -speed
elevators. They're the premium product. And then
you have everything in between. Suburban office
parks, the professional centers. The sources
mentioned Class B and Class C buildings. What's
the difference there? It's a grading system based
on age, quality, and location. Class A is the
best. Class B buildings are a little older, maybe
not in the absolute best location, but still
very functional and desirable. Class C is the
oldest stock, often in need of renovations with
lower rents. Got it. So it's a quality scale.
And despite the rise of remote work, which I
know we'll touch on later in the state of the
market segment, these are still a dominant part
of the landscape. Absolutely. They are the factories
of the knowledge economy. For better or worse,
a huge amount of business still happens in these
buildings. OK, bucket number two, retail. Now,
this isn't just shops, right? The sources broke
this down into some really interesting subtypes.
It seems like there is a whole psychology to
retail real estate. Retail is fascinating because
it is where commerce physically meets the consumer.
The real estate is explicitly designed to capture
your attention and your wallet. So let's start
with the first one on the list, pad sites. That
sounds like a launch pad. In a way, it is. It's
launching a business into the consumer's view.
These are usually single -tenant buildings located
on highway frontages or right in front of a larger
shopping center. Give me an example. Think of
a standalone bank branch in the corner of a Target
parking lot. or a Starbucks or a fast food restaurant
with a drive -thru, a tire shop right on the
edge of a big parking lot, they're on an out
parcel. Got it. The stuff you see right off the
exit ramp, you drive by, you see the sign, you
pull in. It's all about visibility and convenience.
Visibility and access are everything. They pay
a premium for that frontage to be right on the
road. Then you move into the bigger centers.
Next up, you have power centers. Power centers.
That sounds intense. Like a power plant. Well,
it refers to the drawing power of the tenants.
These are large open -air centers dominated by
anchor stores. We're talking about the category
killers. Big box stores. Exactly. Best Buy, PetSmart,
OfficeMax, Home Depot, Target. Ah, the Saturday
afternoon errand run. You go there because you
need something specific. A drill, dog food, a
laptop. And you know for sure they have it. Precisely.
They aren't necessarily designed for leisurely
strolling. They're designed for efficiency and
volume. They are usually long strip centers with
a massive sea of parking in front. Get in, get
your stuff, get out. But then to contrast that,
you have the lifestyle center. The polar opposite
in many ways. I feel like I know what this is
just by the name. It's where you go to hang out.
Yes. This is a blend of indoor and outdoor shopping.
It often tries to mimic a traditional main street
feel. Even if it's built from scratch in the
middle of the suburbs, you see nice landscaping,
fountains, brick walkways. Maybe a cinema. Or
some upscale restaurants mixed in with the clothing
stores, like an Apple store and a Lululemon.
That's the perfect description. It's selling
an experience, not just goods. It wants to be
a destination. It's the place you go to buy a
$6 latte and walk around looking at expensive
yoga pants. Yeah. You aren't just running an
errand. You're spending your afternoon there.
That's the goal. Keep you there longer, which
usually means you spend more money. And finally,
in retail, you have the most common type. The
grocery -anchored community center. So the supermarket
is the big draw. The supermarket is the anchor,
and then you have all the daily needs services
around it. The dry cleaner, the nail salon, the
local pizza place, the UPS store. The neighborhood
hub. This feels really stable, maybe even recession
-proof. People always need groceries and haircuts.
It's considered one of the most stable assets
in retail for that very reason. It's not sexy,
but it's consistent. So retail covers everything
from that local strip mall to the massive regional
shopping malls. It's a huge bucket. OK, moving
on to bucket number three. Multi -family residential.
We touched on this with the five -unit rule.
Yes. So this category includes your standard
apartment complexes. You have garden style, which
are those two - or three -story walk -ups that
are spread out over a lot of land, usually with
some green space. Common in the suburbs. Very.
And then you have the high -rise apartment buildings
in the city. But it also includes things people
might not think of, like student housing and
dormitories. Oh, that's interesting. I hadn't
thought about dorms as commercial real estate,
but of course they are. They generate rent, a
lot of it. Huge amounts of rent, usually. Student
housing is a very specialized niche within multifamily.
You often rent by the bed rather than by the
unit. So four students in a four -bedroom apartment
are each signing their own individual lease.
Correct. Which is great for the landlord. If
one student drops out, you only have a 25 % vacancy
in that unit, not 100%. And because the turnover
is high and guaranteed by the academic calendar,
it's a very specific, predictable asset class.
It's a business model built on semester leases.
And they're often backed by parental guarantees,
which I imagine makes landlords very happy. It
certainly reduces the credit risk. It's a very
attractive model for investors. Okay. Bucket
number four. This one feels like the unsung hero
of the economy, especially these days. Industrial.
Industrial is the backbone. You're right. For
a long time, it wasn't considered sexy real estate.
It was just dusty warehouses on the edge of town.
The places you only see from the highway. Exactly.
But with the rise of e -commerce, it has become
the hottest ticket in town. The Amazon effect.
100 % the Amazon effect. This bucket includes
warehouses and distribution centers, everything
from the massive million square foot fulfillment
centers out in the countryside to the smaller
last mile facilities in the city where your overnight
shipping comes from. What makes these buildings
special? They're just big boxes, right? On the
surface, yes. But they have very specific requirements.
They need incredibly high ceilings, maybe 30
or 40 feet for stacking pallets. They need perfectly
flat concrete floors for the robotic systems.
And they need dozens and dozens of loading docks
for trucks. So it's not just a box. It's a highly
engineered box. And it's not just for storage,
is it? No. It also includes more specialized
facilities. Large R &D research and development
facilities often fall under industrial. Think
about where tech companies build prototypes or
biotech firms have their labs. And there is one
subtype that the sources mentioned that I find
particularly fascinating. Cold storage. Cold
storage, yes. Essentially giant... building -sized
freezers. We aren't just talking about a walking
fridge in a restaurant. No. We are talking about
entire warehouses that are refrigerated to sub
-zero temperatures. These are cold -chain properties.
They are absolutely essential for the food supply,
keeping your frozen pizzas and ice cream frozen
from the factory to the store. And for medicine,
too, right? Crucially, for medicine. Think about
vaccines or other pharmaceuticals that need to
be stored at very specific, very cold temperatures.
The entire supply chain relies on these buildings.
Wow. We don't think about the building that keeps
the medicine safe. But without that specific
piece of commercial real estate? The whole system
breaks down. And building a cold storage facility
is much more expensive and complex than building
a regular warehouse. You need massive insulation,
specialized HVAC systems, redundant backup power
generators because you absolutely cannot lose
power for even an hour. It's a very technical,
very expensive asset. Incredible. OK, bucket
number five, land. This seems straightforward,
but I assume there's nuance here, too. It's not
just buying a field. There is. You have investment
in raw rural land, often called greenfield land.
This is often a speculative play. You're buying
land in the path of future development. So you're
betting. You're betting that the city will expand
in that direction. You're waiting for the suburbs
to crawl out to you. It might be a cornfield
today, but you're betting that in 10 years it's
going to be a new subdivision or a shopping center.
A long -term game. Very. And then in contrast,
you have infill land. This is vacant land within
an already urbanized area. Maybe it's an old,
underused parking lot in downtown that is ripe
to become a new condo building. Infill. I like
that term. It's like you're filling in the gaps
of the city. Exactly. It's often more valuable
per square foot because the infrastructure, the
roads, the water, the power is already there.
You don't have to pay to run a sewer line five
miles to get to it. Makes sense. And finally,
bucket number six, the miscellaneous or catch
-all drawer. The industry sometimes calls this
special purpose real estate. It's everything
that doesn't neatly fit into the other categories.
So what's in there? It includes hospitality,
so hotels and motels. It includes medical centers,
hospitals, nursing homes, outpatient clinics.
Which are huge businesses unto themselves. Massive.
And a very popular one these days is self -storage.
Self -storage seems like it's everywhere. There
are new ones popping up all the time. Why is
that considered such a good business? It is a
really unique asset class because the tenant
is just regular people storing their excess stuff,
holiday decorations, old furniture, things they
don't have room for. But the operating costs
are very, very low compared to, say, an apartment
building. How so? Well, boxes of old sweaters
don't call you at 3 a .m. to say their toilet
is clogged. Right. They don't complain about
noisy neighbors. You don't have to fix leaky
faucets or repaint walls nearly as often. There
are no tenants. to screen, really. It's a very
low -maintenance, steady source of rent. That
makes a ton of sense. It's a simpler operation.
Much simpler. Now, before we leave these buckets,
we have to talk about how they blur together
in the real world. We have to talk about zoning
and mixed -use development. Right, because in
a city, you rarely see just a field of office
buildings and then a mile away, a field of shops.
They're all mixed up. Sometimes they're stacked
on top of each other. Especially in modern urban
planning. A single commercial building might
have retail on the first floor. That's your coffee
shop and your bank. Then floors 2 through 10
might be offices. And then floors 11 through
20 might be residential apartments or condos.
So what bucket is that? Is it retail, office,
multifamily? It's mixed use, and this is all
dictated by zoning. Local authorities, your city
or county government, have very strict regulations.
You can't just open a factory in the middle of
a quiet neighborhood. A business must be located
in an area that is zoned for commerce. So the
city planners are literally the ones drawing
the lines on the map, saying, this corner is
for shops, this block is for houses. Yes. And
they have the authority to change those designations,
which can massively increase or decrease the
value of a property overnight. If you own a piece
of farmland on the edge of town and the city
rezones it for commercial, you just hit the jackpot.
Your land value could go up 10x in a day. It's
like a game of SimCity, but with very, very real
money. Extremely real money. So we have the map.
We know the six buckets. Office, retail, multifamily,
industrial land, and miscellaneous. Now let's
transition to the engine room, segment two, the
money machine. The investment mechanics. Right.
Because, as we said at the top, the definition
of this property is the intent to make a profit.
So how do they actually make money? I'm assuming
it's not just collecting a rent check and putting
it in the bank. No, it's much more complex than
that. To really understand the profitability
of a commercial building, you have to look at
the cash inflows, the good column on the spreadsheet.
and the cash outflows, the bad column. Let's
start with the good, cash inflows. Obviously,
rent is the big one. That's number one on the
list. Rent is the primary driver, absolutely.
But there are other important streams of income.
One of the most important concepts in commercial
real estate, and one that totally differs from
residential, is operating expense recoveries.
Operating expense recoveries. That sounds like
some kind of legal jargon. What does it mean
in plain English? It means the tenant pays the
landlord back for the costs of running the building.
Oh, really? So the tenant is paying more than
just their rent? In many cases, yes. It depends
on the lease structure. For example, in what
we call a triple net lease or an NNN lease, which
is very common in retail and industrial. Triple
net. What are the three nets? The three nets
are property taxes, building insurance and maintenance.
So the tenant pays their base rent to the landlord,
but they also pay their proportional share of
those three expenses. So if the parking lot needs
to be plowed in the winter, The tenant effectively
pays for it. Indirectly, yes. The landlord hires
and pays the snowplow company, and then at the
end of the year, they reconcile the expenses
and bill the tenants for their share. That reimbursement
is a cash inflow for the landlord. That is a
fantastic deal for the landlord. It protects
the landlord from rising costs. If the city raises
property taxes by 20%, the landlord doesn't care.
That cost is passed directly through to the tenant.
It makes the landlord's net income very predictable
and stable. Wow. Okay, so what else comes in
besides rent and these recoveries? Fees. All
sorts of fees. Parking fees are a big one in
downtown office buildings or apartment complexes.
You could have vending machines, laundry machines
and apartment basements. Fees for using a clubhouse
or a gym. Renting out the roof for cell phone
towers. That's another great example. Those can
be very lucrative. All these little trickles
can add up to a significant river of revenue
over time. And then there are the invisible inflows,
the tax stuff. This is where it gets really interesting.
Yes. The tax benefits are a huge reason why wealthy
investors love. real estate. And the biggest
one is depreciation. I've always found this concept
so confusing. Depreciation means the building
is getting older and less valuable, right? It's
losing value. How is that a benefit? It's what
we call a phantom expense. The tax code allows
you to assume that the physical structure of
the building is wearing out over a set number
of years. For commercial property, it's currently
39 years. So every single year, you get to deduct
139th of the building's value from your taxable
income as if it were a real cash expense. But
you didn't actually write it. check for that
amount. No money left your bank account. Exactly.
You didn't spend the cash. So you might have
positive cash flow, real money in your pocket
from the rent after paying all the bills. But
on your tax return, you could actually show a
loss or a much lower profit because of this massive
depreciation deduction. So it shelters your real
income from taxes. It's one of the most powerful
wealth building tools there is. You make money,
but you get to tell the IRS you didn't legally.
And there are other things, too, like historic
tax credits. If you renovate a designated historic
building, the government gives you incentives.
OK, that's the sunny side of the ledger. Now
let's look at the dark clouds, the cash outflows,
the bad column. Well, the biggest one starts
on day one, the initial investment. Your down
payment. Commercial loans aren't like the 3 %
down home loans you see advertised. They often
require substantial equity. How much are we talking?
20, 30, sometimes even 40 % down in cash. So
if you're buying a $10 million building, you
need $3 million in cold hard cash just to get
in the game. Correct. Then after that, you have
the biggest recurring outflow. Debt service.
That's your mortgage payment. Principal and interest.
The bank always, always gets paid first. The
monthly nut you have to crack. Then come the
operating expenses, the ones that aren't reimbursed
by tenants or that you have to pay during periods
when the building is empty. Property taxes, insurance,
utilities, landscaping, janitorial, property
management fees. The list goes on and on. You
have to pay the person who fixes the toilets.
And things break. Big things. That's the next
category. Capital expenses or capex. This is
the oh no fund. This is for major non -recurring
items. The roof leaks and needs to be replaced.
The HVAC system dies on the hottest day of the
year. The parking lot needs to be completely
repaved. These are big, lumpy expenses that can
just appear out of nowhere. And they can wipe
out an entire year's profit if you haven't been
saving for them in a reserve account. A new roof
on a large building can cost hundreds of thousands
of dollars. And there's a cost to getting tenants
in the first place, right? The outline mentioned
leasing costs. Yes, and this is another huge
difference from residential. In residential,
you might just post an ad on Craigslist or Zillow
for free. In commercial, you almost always have
to pay a broker a commission. And how much is
that? It can be a percentage of the total value
of the lease over its entire term. So if you
sign a tenant to a 10 -year lease worth a total
of $1 million in rent, you might have to pay
a broker a $30 ,000 or $40 ,000 commission right
up front. Wow. That's a huge check to write.
It is. And on top of that, you often have to
pay for tenant improvements or TIs. What are
TIs? Let's say a law firm wants to rent your
empty office space, but the layout is all wrong
for them. They need five new glass conference
rooms and a fancy new kitchen. As the landlord,
to entice them to sign that long -term lease,
you might agree to pay for those renovations
yourself. So you're spending tens or even hundreds
of thousands of dollars before they even move
in and pay you a single dollar of rent. You are
spending money to make money. Always. You are
essentially investing in that tenant's business
in the hopes of securing their long term rent
payments. Now, this brings us perfectly to the
concept of risk. You mentioned earlier that risk
in this game isn't just will the building burn
down? No, fire is easy. Insurance covers fire.
The real day to day gut wrenching risk in commercial
property is tied to tenancy. The people inside,
the businesses renting the space. Specifically,
tenant renewal risk. It's a game of probability.
When a tenant's 10 -year lease ends, will they
sign up for another 10 years? Because if they
don't, if they don't, you have a vacancy. Suddenly
you have zero rent coming in from that space.
But you still have to pay 100 percent of the
mortgage, the taxes and the insurance for it.
And now you have to go out and pay a broker a
huge commission to find a new tenant and then
pay for a whole new round of tenant improvements
to suit the new business. So a vacant building
is just a cash burning furnace. It is toxic.
It is the number one killer of real estate investments.
That is why investors look so closely at the
credit worthiness of a tenant. A 10 -year lease
with a Fortune 500 company like Starbucks is
worth infinitely more than a 10 -year lease with
Bob's Coffee Shack. Because the probability of
Starbucks being around and paying rent for the
full 10 years is much, much higher. Exactly.
The whole business is about predicting the future
cash flows. You're analyzing the timing and the
amount of money. What is the probability that
the cash will come in when you expect it? And
what is the probability of an unexpected outflow,
like a major repair, a lawsuit, or a natural
disaster? It's not just owning bricks. It's owning
a stream of probabilities. Beautifully put. That's
exactly what it is. Okay, so we know what the
buildings are, and we know how the math works.
Now let's talk about how you actually go about
buying one. Segment three, how the sausage is
made. The transaction process. Buying a house
is stressful enough for most people. I have to
imagine buying a shopping mall is worse. It is
exponentially more complex with many more moving
parts and much higher stakes. It's a rigorous,
multi -stage process that can easily take six
months or even a year from start to finish. Walk
us through the life cycle. Step one, the search.
How do you even find a building to buy? It usually
starts with a broker. In the commercial world,
listings aren't always public like they are on
Zillow for Houses. Brokers are the gatekeepers.
They market a property on behalf of the seller
and they identify properties for a buyer based
on very specific criteria. Criteria like, I want
a warehouse in Ohio. Much more specific than
that. It's more like. I want an industrial warehouse
between 50 ,000 and 100 ,000 square feet built
after the year 2000, located within 10 miles
of a major highway with at least a 6 % return
on investment. Oh, wow. OK, so very targeted.
And you have different kinds of buyers looking
for these things, right? You have the owner user.
That's the business that wants to own its own
building to operate out of like a manufacturing
company. And then you have the investor, the
person or company who just wants the ash flow.
This could be a private individual or a massive
private equity firm like Blackstone. Okay, so
the broker finds a property that fits the criteria.
Do they just make a formal offer? Not usually.
They typically start with an LOI, a letter of
intent. The outline called this dating before
marriage. I like that. That is a perfect analogy.
An LOI is a non -binding or mostly non -binding
document that outlines the major business terms
before the lawyers get involved. It will have
the price, the proposed closing date, the length
of the inspection period, the big stuff. So it's
not a legal contract to buy. Correct. It's more
like a handshake on paper. It says, I am serious
about buying this property and here's generally
what I'm willing to do. The main benefit is that
it saves money. You don't want to pay a lawyer
$500. an hour to draft a 50 -page contract if
you can't even agree on the price. That's smart.
So you agree on the LOI, you've had a few dates,
you like each other, then comes the engagement
ring. Then comes step two, the PSA, the purchase
and sale agreement. This is the formal, legally
binding contract. This is the marriage contract.
And this is where the money gets real. Yes. At
this stage, the buyer is commonly required to
submit an escrow deposit or earnest money. It's
a good faith deposit held by a neutral third
party, like a title company. How much are we
talking? It can be 1 % to 5 % of the purchase
price. So on that $10 million building, you're
putting up $100 ,000 or more just to show the
seller you're not wasting their time. And then
the clock starts ticking on the most important
part. Step three, due diligence. The detective
work. This is the most critical phase of the
entire transaction. What are they looking for?
What's in the file? Everything. Unlike buying
a house where you just get a simple home inspection,
commercial due diligence is a full forensic audit
of the property. Give me the checklist. Okay.
You review the property financial statements
for the last three to five years. Are the sellers
telling the truth about how much money the building
makes? You review the rent rolls. Who are all
the tenants? How much space do they have? When
do their leases expire? And most importantly,
are they actually paying their rent or are they
three months behind? You check the vendor contracts,
who picks up the trash, who mows the lawn, and
can I cancel those contracts or am I stuck with
them? You check the zoning. Is the building actually
legal for its current use? Or was it grandfathered
in under old rules that could cause problems
later? You check trapping patterns. Is the city
about to close the road in front for a year for
construction, killing your retail tenants' business?
And the physical building itself. Of course.
You hire engineers to inspect the roof, the structure,
the HVAC, the elevators. But just as important
is the environmental condition. This is huge.
Environmental. Like, is it a green building?
No. Like, is the ground underneath it contaminated
with toxic waste? Oh. This is an absolute nightmare
scenario. Let's say you're buying that strip
mall and 30 years ago, one of the tenants was
a dry cleaner. Okay. Old dry cleaning businesses
used very harsh industrial chemicals. If those
chemicals leaked into the ground over the years,
you have serious soil contamination. If you buy
that building, under the law, you become the
new owner of that pollution. You are now liable
for cleaning it up. Even though you had nothing
to do with it. Even though it happened decades
before you were born. And the cleanup could cost
more than the building itself is worth. So you
always, always order a Phase 1 environmental
report to check the history of the site and look
for red flags. Yikes. So you really have to turn
over every single stone. This is where contingencies
come in. The PSA, that legal contract, usually
says, I will buy this building contingent on
me approving all of this stuff during my due
diligence period. If I find a problem, bad soil,
a bad roof, a major tenant about to go bankrupt,
I can back out of the deal and get my deposit
back. It's your skate patch. Your get -out -of
-jail -free card. It is. But here's the twist.
In a hot competitive market when lots of people
want to buy the same building, buyers might waive
these contingencies to make their offer look
more attractive to the seller. So they're saying,
I promise to buy it no matter what I find, even
if I haven't checked the plumbing yet. That sounds
incredibly dangerous. It's high stakes poker.
You are betting that the risk is manageable because
you want to win the asset so badly. You're flying
blind. Okay, so let's say the detective work
is done. You didn't find any toxic waste. The
roof is okay. The numbers check out. What happens
next? Step four, hard money and closing. At a
certain date that's defined in the contract,
the contingency period ends. At that point, the
escrow deposit becomes hard, which means it's
non -refundable. The point of no return. That's
it. If you walk away from the deal for any reason
after this point, the seller keeps your money.
They keep that $100 ,000 deposit just for the
inconvenience you caused them. That definitely
focuses the mind. It does. It forces you to commit.
And then finally, you have the closing. The funds
are wired from the lender and the buyer. The
title is legally transferred. The keys are handed
over. And you now own a commercial building.
And then the real work begins. actually managing
the thing. Right. Notifying all the tenants there's
a new owner, transferring the vendor relationships,
and crossing your fingers that the roof doesn't
leak the next day. Incredible. It really is a
massive operation compared to buying a house.
Now, I want to pivot here. We've been talking
about how things work in theory, the buckets,
the money, the transaction process, but we have
some very fresh, very specific data. about what
is happening right now in the real world of commercial
real estate. The 2024 -2025 Snapshot. Segment
four, the state of the market. And folks, you
might want to buckle up because there is some
serious turbulence ahead. There is. Let's start
with the most recent data point we have from
the sources. The confidence drop in April 2025.
This comes from the 1Q 2025 Board of Governors
Sentiment Index. What did they find? They measure
what they call positive sentiment. It's basically
a poll of the big players in the industry, the
developers, the lenders, the brokers, asking
how good do you feel about the future? In late
2024, that number was at a very healthy 126 .5%.
Okay, so people were optimistic. Very, but by
April 2025, it had crashed to 87 .9%. That is
a massive drop. That's not a dip, that's a cliff.
It is the single steepest drop in confidence
since the start of the COVID -19 pandemic. The
market got very scared very fast. And do we know
why? The source was pretty specific about the
driver for this. Yes. The source explicitly attributes
this sharp drop to the Trump administration's
latest tariff policies. OK. So let's just report
on the mechanics here without taking any political
sides. Yeah. Why would tariffs on foreign goods
hurt real estate sentiment in the U .S.? It comes
down to two things. Costs and uncertainty. Tariffs
usually mean higher costs for raw materials that
are using construction steel, glass, lumber,
concrete, HVAC equipment. If it suddenly costs
20 % more to build a new building because steel
is more expensive. Developers stop building.
It freezes new projects. It creates a supply
shock and grinds development to a halt. And just
as importantly, it creates massive uncertainty.
Markets hate uncertainty more than anything.
If global trade flows are disrupted, that affects
the tenants who occupy these buildings. It affects
the warehouses that store imported goods. It
affects the retailers that sell those goods.
If the tenants' businesses are hurting, the landlords
get very worried about their ability to pay rent.
So the data from this source shows the entire
industry is spooked by this policy shift. So
sentiment is way down. But let's look at the
office market specifically. We have a really
weird paradox here in the 2024 data. The office
space paradox, yes. If you just look at the headline
numbers, the leasing volume, the amount of new
office space rented in 2024 actually rose to
its highest level since 2020. Which sounds good.
That sounds like a recovery. People are going
back to the office. Companies are renting space
again. But... There is a huge catch, a massive
catch that changes the entire story. The source
notes that roughly 60 % of all active office
leases currently in effect went into effect prior
to the pandemic. Wait, unpack that for me. 60%.
Why is that a problem? It means that more than
half of the companies occupying office space
right now are sitting on legacy leases. They
signed these contracts in, say, 2018 or 2019,
usually for a term of 7 to 10 years. They are
still paying rent. based on the old world logic
before remote work became mainstream. So they
might have a giant office that is half empty
because everyone is working from home on Tuesdays
and Fridays, but they are still stuck in that
10 -year lease they signed in 2019. Exactly.
They haven't had to make the hard decision yet
about their future space needs. They are just
paying rent on thousands of empty desks because
the contract says they have to. But as those
leases expire over the next few years... We are
facing a looming cliff. A lease expiration cliff.
A massive one. When those companies finally come
up for renewal, are they going to renew for the
same amount of space? Almost certainly not. They'll
downsize. They'll realize they only need half
a floor instead of a whole floor. Or they might
decide to go fully remote and get rid of their
office entirely. So that high leasing volume
statistic for 2024, it masks this ticking time
bomb of expirations. The real pain hasn't fully
hit the market yet. We're in the eye of the storm.
That is a scary thought for anyone who owns an
office building. And we are already seeing signs
of trouble. The source has mentioned distress.
Yes. The data from Real Capital Analytics is
pretty stark. It shows that over $160 billion
of U .S. commercial properties are currently
in some form of distress. What does distress
mean? It means they are in default on their loan,
they're in the process of foreclosure, or the
owner is in bankruptcy. $160 billion. That's
not small change. That's a huge number. It's
a very significant chunk of the market that is
actively failing to pay its debts. And that number
has been rising steadily. And it's not just a
U .S. problem, right? We have data on Europe
as well. No, this is a global issue. Europe is
facing what many analysts are calling a debt
wall. A debt wall. According to the sources,
there is 960 billion of debt backed by European
commercial real estate. Nearly a trillion euros.
And here is the kicker. Half of that debt, almost
500 billion, needs to be refinanced in the next
three years. Why is that a problem? Can't they
just go to the bank and get a new loan when the
old one comes due? Because the entire environment
has changed. Interest rates across Europe and
the world are much higher now than they were
when those loans were taken out five or seven
years ago. If you borrowed money at 2 % interest
and now you have to refinance at 5 % or 6%, your
monthly mortgage payment could double or even
triple overnight. But your rental income from
the tenants didn't double. Exactly. Your income
is flat, but your biggest expense just exploded.
So suddenly the math breaks. The building's income
can no longer pay the mortgage. This puts massive
downward pressure on valuations. If the building
can't support the debt, it's worth less. And
if it's worth less than the loan amount, the
bank has to take a huge loss. And this matters
to everyone because... Yes. The sources note
that the commercial real estate sector secures
approximately 4 million jobs across Europe. That's
construction workers, architects, engineers,
property managers, brokers, lawyers, accountants.
If the sector seizes up because of this debt
wall, millions of jobs are at risk. It's all
connected. The tariffs in the U .S. affecting
construction costs, this debt wall in Europe
affecting the banks, the ghost leases in office
towers affecting the viability of our downtowns.
It is a very precarious moment. We are in a major
transition period between the pre -pandemic economy
and whatever is settling in now. And commercial
real estate is the physical place where all that
tension is being felt. Wow. OK, let's try to
wrap this up. We have covered a lot of ground
today. We certainly have. We started by defining
the beast. Commercial property. is anything with
the intent of profit, from that tiny five -unit
apartment building all the way up to a skyscraper.
We mapped out the six buckets, office, retail,
multifamily, industrial, land, and the catch
-all miscellaneous bucket. Then we looked under
the hood at the money machine, how inflows like
rent and those important expense recoveries battle
against outflows like debt and the dreaded capex.
We learned about the phantom expense of depreciation
that shelters income. And we walked through the
anxiety of the transaction from the dating phase
of the LOI through the detective work of due
diligence all the way to that point of no return
with hard money. And finally, we looked at the
storm clouds that seem to be gathering in 2025,
the tariff -driven sentiment drop, the $160 billion
already in distress in the U .S., and that looming
office lease cliff. It's a complicated picture.
It's an industry in major flux. That's putting
it mildly. So what does this all mean for the
listener? Why should someone who doesn't own
a skyscraper care about any of this? Because
whether you invest in it or not, you exist in
it. And its health affects you. This sector holds
trillions in value, that $6 trillion number in
the U .S. alone. It drives millions of jobs.
And when commercial real estate values drop,
it hits the pension funds that invest in these
buildings on behalf of teachers and firefighters.
It hits the regional banks that lend to them,
which could lead to a credit crunch for everyone.
And it hits city tax revenues. How so? If that
big office building downtown loses half its value
because tenants are leaving, the city collects
a lot less in property tax from that building.
And that might mean less funding for schools
or parks or the fire department. It is the invisible
scaffolding of our civic society. I want to leave
everyone with a final provocative thought, building
on what we've discussed. We talked about that
office paradox. 60 % of leases are these ghosts
from before the pandemic. And we talked about
sentiment dropping sharply due to new tariff
policies in 2025. Right. Two separate storm systems.
So here's the question. What happens if those
ghost leases finally expire and companies start
downsizing en masse at the exact same moment
that the broader economy is getting hit by tariff
shocks and the pressure of high interest refinancing?
What happens to our downtowns when those two
timelines finally collide? That is the multi
-trillion dollar question, isn't it? Are we looking
at a slow, manageable correction? Or are we looking
at a genuine hollowing out of our urban cores?
Something to think about the next time you walk
past an office tower at night. Look up at the
windows. How many of them are dark? And more
importantly, who is still paying for them? For
now. Thanks for joining us on this deep dive.
We hope you will never look at a strip mall the
same way again. See you next time. Stay curious.