If you’re making your move into commercial real estate, even if you already have some experience under your belt in residential real estate, there are going to be a few commercial real estate terms you should know. Having this new vocabulary will help you navigate the complex world of commercial properties and ensure two very important necessities for your success:
- that you understand your lease and the agreement you’re entering, and
- that you can communicate your needs to the other people involved in your transaction.
Unlike residential real estate, where many of the terms are familiar to anyone who has bought or rented a home, commercial real estate has many terms that will probably be foreign to you. Whether you’re buying a commercial property with the intention of renting it out, or you’re a business owner looking to rent commercial property from a landlord, here are a few terms you will want to understand.
Usable Square Footage
This is the amount of space within the building that is available for use (that is, available to be rented out), as opposed to the amount of space that can’t be rented. Space that can’t be rented might include the building’s foyer, hallways, stairwells, elevator atriums or even shared bathrooms. Even though these contribute to the overall square footage of the building (known as the rentable square footage), these parts of the building aren’t used exclusively by any single tenant.
The only time these parts of the building would be considered usable square footage would be if a business owner is renting out an entire floor of an office complex and had exclusive use of the hallways, bathrooms and elevator atriums.
Common Area Maintenance (CAM):
This is the amount of money a landlord or property owner needs to spend to maintain the building. This cost could be divided up and passed on to the tenants, who will pay this cost on top of the amount they pay in rent. If this is the case, it should be specified in the lease. A CAM might be either flat or variable. If it is variable, a tenant might want to negotiate a cap on the CAM rate so that it doesn’t exceed budget.
In this type of lease, all expenses — including not only rent but also utilities, repairs, taxes and even insurance — are all included in one amount. Compare this with a triple net lease, where the tenant pays the rent and then is responsible for paying things like utilities and insurance separately. The third type of lease is a modified gross lease, where the tenant and property owner agree on how to divide the expenses between them.
Net Operating Income (NOI):
This is a commercial real estate term that is important for landlords to understand. The NOI is calculated by looking at the gross amount of rent you’re collecting and subtracting your expenses. In shorty, it’s how much money you’re making in the end. The NOI determines your property values, as a high NOI can indicate a valuable property and a low NOI can mean a property with less value.
Price Per Unit:
This number will help a property owner decide how much to charge in rent for each unit. For example, if you buy an office complex for $700,000 and it has 20 equally sized commercial spaces available in it, each of those commercial spaces is worth $35,000. Compare this commercial real estate term with price per square footage, which considers how much each square foot of the property is worth based on the overall value of the property divided by the amount of space.
If you’re a business owner renting out a property, it’s to your advantage to have a clause that permits subletting to another tenant in the event that you have an emergency or other unforeseen circumstance that forces you out of the space before your lease is up. In some cases, a property owner might include a clause prohibiting subleasing, and you should consider what this means for you. If you outgrow the space faster that you anticipated, you don’t want to hold off on expansion simply because you have another year left on your lease.
This commercial real estate term is pretty self-explanatory. An escalation clause lets the tenant know how much the rent will increase (or escalate) every year.
Right of First Refusal:
This is a commercial real estate term that will be important for tenants. Let’s say a business owner rents a suite in a commercial complex but is interested in renting the adjacent space when it becomes available, either because the tenant wants to move from one space to another or because the tenant wants to occupy both spaces at the same time. Including the right of first refusal in the commercial real estate lease means the current tenant has first dibs on any other space the landlord has available before the real estate is offered to the public.
This specifies exactly what changes a tenant can make to a property to suit their needs. Whether it’s a major renovation, carpeting or painting, these changes might be permitted or prohibited. In the case of permitted tenant improvements, the property owner might agree to handle some or all of the cost.
There is a saying we like, “stick to your knitting.” It means stick to the thing that you are good at. For us that is commercial real estate. If you want someone with the experience to guide you through the process the Murphy Commercial team can help. Visit us at Murphy Commercial Real Estate