17 Commercial real estate terms you should know
Commercial real estate is far more complex when compared to its residential counterpart. The contracts are longer here, including higher price tags, capital investments and many complex terms that an ordinary person does not understand. So, to ride your business through the waters of commercial real estate, it’s important to understand the terminology used by those in the industry. Make sure you understand these commercial real estate terms before entering into a commercial real estate deal…
17 Commercial real estate terms you should know
Commercial property or asset is defined as any building or land used by a commercial business for making a profit. The industry is classified into three types – retail, office and industrial.
Net operating income
NOI is an income you generate annually from an income property or an asset after property expenses have been taken into consideration.
Net operating income = (Rental income + other income – Vacancy and credit losses) – Operating expenses
Tenant Representative
A tenant representative is a commercial real estate realtor that represents the tenant instead of the landlord. The tenant rep helps identify office space and negotiate with the landlords.
Landlord Representative
A landlord representative is the leasing agent. They represent the best interests of the owner and are responsible for gaining the highest amount of rent with the least amount of risk.
Co-broker
Many times a landlord will sign an exclusive listing agreement with a commercial real estate broker. So, to expand the reach and get the asset rented faster, the broker will invite other brokers to view and rent the property, and split the commission with them.
Usable square footage
Usable square footage is the amount of space that is available to be used in a commercial rental property. Non-exclusive spaces such as restrooms, lobbies, hallways, storage rooms, stairways are not included in this USF. However, USF gives you an accurate idea of how much working space you have.
Rental square footage
RSF/rental square footage is the total amount of space including any shared space. This comprises the shared lobbies, restrooms, storage areas, hallways (which you pay for). To calculate RSF or rental square footage you need to determine the common area factor. Landlords primarily use this number to determine the rental amount for the commercial asset.
Return on investment
ROI or return on investment stands for the calculated benefit of an investment, divided by its cost.
Return on investment = (Current Asset Value – Cost of investment)/ Cost of investment
Capitalization Rate (CAP Rate)
The CAP Rate is the rate of return an owner can expect to generate. To calculate this rate, the tenant will check the ratio of the net operating income compared to the current market value of the property. This result gives you the return rate or set out on your real estate interment.
Common area maintenance
Common area maintenance is the number of expenses you are responsible to pay for maintaining the building. Each landlord calculates it differently. So, you should inquire with the landlord how the common area maintenance or CAM has been calculated.
Building classification
Property values are determined by asset classifications. Investment property falls under 4 categories – Class A, B, C, and D.
Class A properties refer to properties that are in high demand in the market. They typically boast impressive aesthetics and construction. Equally, require little renovations. While, properties in classes B, C or D are classified as fewer income properties with less appealing features.
Occupancy costs
Occupancy costs are a cost incurred from operating a business within a commercial property. These expenses include property taxes, rent, security, insurance and equipment for business operations.
Tenant inducements
When commercial buildings are not occupied, they shift from being a profitable investment to an expense. To encourage business owners to lease space in that building, the building landlord will provide incentives to potential tenants.
Concessions
These commercial lease concessions are negotiated allowances, which include discounted or free rent for a fixed period, tenant improvement allowances or reduced escalations.
Letter of intent to lease a commercial office room
LOI is a written document that solidifies the tenant’s commitment to rent the space. This comes before signing the lease agreement and typically summarizes the terms of the lease including concessions, negotiations, and timeframes agreed to.
Debt coverage ratio
Also called a debt service coverage ratio, compares an investment property‘s NOI with its impending debt service. Lenders use this ratio to calculate whether you will be able to generate enough income to pay your debts or not.
Triple net lease
Triple net lease or NNN is a lease where the tenant pays all operating expenses like maintenance and repairs. This can be considered a good agreement for the landlord, but for tenants, it has many pros and cons.
Loan to value ratio
An important term in real estate investment! The LTV or loan to value ratio is determined by what percentage an asset’s sale price or value is attributed to financing.
LTV = Mortgage amount/Appraised asset value