When Wharton Global Youth met up with Margaux D.K., a Wharton School senior at the University of Pennsylvania who is heading into a real estate career, she defined her passion for real estate like this: “I appreciate that we are investing in something tangible and helping to shape communities.”

Think about that neighborhood vision for a moment, in particular an urban streetscape or skyline (after all, Wharton is based in the city of Philadelphia — pictured above). Perhaps shaping of communities involves designing and constructing a new 20-story apartment building from the ground up or converting a vacant Baptist church into condominiums or a new charter school. Or maybe that real estate project requires even more creative thinking, like turning Philadelphia’s 40-acre, 40 building historic Arsenal (a property on the market for redevelopment) into a campus for living, working, retail, restaurants and more.

All of these deals are examples of commercial real estate – what you might call the other side of the business from residential — or buying and selling houses. (Get a greater glimpse of the global commercial real estate marketplace at LoopNet.com.)

Commercial real estate, according to Wharton’s Todd Sinai, is income-producing real estate that is invested in, rather than owner-occupied housing. “This includes properties like apartment buildings, hotels, warehouses, retail malls and office buildings,” noted Dr. Sinai, a professor of real estate, business ethics and public policy, during a lecture he gave to Wharton Global Youth students who were studying on Wharton’s campus. “The key distinction is that commercial real estate generates income through rent paid by tenants, whereas owner-occupied housing does not produce income. Commercial real estate is considered an investment, where the goal is to generate returns.”

What should we understand about this dynamic and diverse asset class, otherwise known as commercial real estate? Professor Sinai shared these 6 insights:

1️⃣ The Wharton School focuses its academic study in this area on real estate finance. “Our students [like Margaux, an undergrad, as well as graduate MBAs] invest in commercial real estate. They are working at or running companies that own portfolios of properties. They buy and sell properties, and those properties might be anywhere from $5 million to $500 million or $1 billion,” noted Sinai. “Our students become investors. They become brokers, matching buyers and sellers of real estate. They lend, making loans on real estate. They’re investment bankers. And they build new real estate.”

2️⃣ The U.S. has $18 to $22 trillion of commercial, income-producing real estate. It has much, much more owner-occupied housing.

3️⃣ Return on investment is the cash flow that you get while you hold an investment, and then however much you get for it when you sell it, compared to how much you paid for it. “Real estate is no different,” said Sinai. “The cash flow that you get on real estate is the rent that tenants pay you, minus the expenses that you have to pay for running a building. And at some point, if you sell the property, someone else is going to decide how much to pay you for it. And then you’ll sell it to someone. So, that gives you your return — it’s dividends, which, in the real estate case is rent. And it’s capital gains: how much more did you sell it for than what you paid for it?”

4️⃣ It’s valuable to understand the economics of real estate markets, like the concentration of population in metropolitan areas and what makes people willing to pay a premium to live and work in certain locations – as Sinai asked: “What drives the value of the underlying real estate?”

5️⃣ Performance can vary across different real estate sectors. “You try and manage around the cycle in real estate; it’s very cyclical,” noted Sinai. “You have these crashes that are driven by building more than what you need. For example, warehouse prices are really high; we’re building a ton of them right now. Warehouse demand is really high, so we’re filling them. At some point we are going to keep building warehouses, and they’re going to stop getting full. You look for factors like how quickly the space gets rented, how many tenants are competing for the same base and other measures like how tight the market is. But it’s genuinely hard to tell [when demand will drop off].”

6️⃣ Disruptive trends like e-commerce (not as many trips to the retail mall), working from home (fewer days in the office high-rise) and climate change (shifting flood zones around buildings) are impacting the commercial real estate market and investors. “In Miami, a six-foot rise in sea level all of sudden changes where you might want to have property in Florida,” observed Sinai. “They calculate that a 20-foot sea wall would be needed to protect the city from climate change, which blocks the views out of the first two floors of anything that’s oceanside. That changes the value of the existing real estate. E-commerce changes where people want to shop. All these things are an upheaval right now, which makes it an interesting time to be doing real estate.”

Conversation Starters

How does commercial real estate differ from residential real estate?

Has a commercial real estate project around your neighborhood caught your eye recently? Describe it in the comment section of this article and think about it from a business perspective? What questions bubble up for you around this reshaping of your community?

High school student Anthony W. says, “Behind every influencer are years of relentless hard work.” Do you agree with him? Why or why not?

Hero image photo of the Philadelphia skyline shot by: ActionVance on Unsplash