In commercial real estate, there are a lot of acronyms and definitions we use! In this blog, we will break down some of the most common/ important terms used in commercial real estate!
Investment Terms
Cap Rate
A cap rate is the return on a real estate investment on an annual basis.
To find the cap rate, divide the net operating income (income minus expenses) by the purchase price of the property.
The result is the cap rate.
Usually the higher the cap rate, the higher the risk (and the lower the value) of the property.
Alternatively, the lower the cap rate, the lower the risk (and the higher the value) of the property.
Investors use cap rates because they provide an apples to apples comparison among returns of different investments.
Example
Income $75,000/year
Expenses $20,000/year
NOI $55,000/year
Purchase Price $700,000
$55,000/$700,000= 7.86% cap rate
IRR
IRR stands for the internal rate of return of a property.
The IRR is the rate of return of each dollar of an investment as long as the money stays in the investment.
IRR takes into account the original dollars put into the investment, the cash flows to be received, and the expected disposition price of the investment.
IRR is more comprehensive than the cap rate.
Lease Terms
Lessor: The building owner; the one leasing their property to a tenant.
Lessee: The tenant; the one who will be leasing a space from the building owner.
NNN Lease
A lease where the tenant agrees to pay taxes, insurance, and building maintenance expenses in addition to the base rent amount.
Gross lease
A lease where the tenant pays a flat fee for rent and does not pay NNN fees
Modified Gross Lease
A lease where the tenant pays base rent, and the landlord and tenant share the property’s operating expenses (expense responsibilities specific to each individual lease).
Tenant Improvements
Improvements/changes the landlord will either pay for or reimburse the tenant for as part of the lease agreement.
Sublease/Sublet
When the tenant (sublessor) leases the property (sublet space) to another tenant (sublessee).
CAM
Means common area maintenance.
Common areas are spaces that more than one tenant shares (hallways, shared bathrooms, etc). CAM charges are when the landlord prorates each tenant’s share of expenses for the common areas and passes those expenses along to the tenants.
Useable Square Footage
Total useable square footage in a building (includes hallways, common areas, etc)
Rentable Square Footage
The square feet that can be rented to a tenant. Rentable square feet is useable square feet minus common area square feet.
Parking Ratio
The ratio of parking spaces per 1000 square feet of leasable area.
Landlord and Tenant Rep
Landlord Rep: The broker/agent representing the owner of the property when leasing a building/space.
Tenant Rep: The broker/agent representing the tenant who is leasing a building/space.
Contract Terms
LOI
LOI stands for Letter of Intent. A letter of intent is presented before an official contract. It is a non binding agreement between the buyer and seller or lessor and lessee that outlines the terms of the contract/lease.
Earnest Money
The money that is deposited with an escrow agent when a property goes under contract. The earnest money is used as consideration for the contract and shows good faith from the buyer.
Due Diligence
A time period designated in the contract where the buyer can perform all necessary activities and inspections to ensure they wish to purchase the property.
Vacancy Rate
The rate of unoccupied (vacant) square feet relative to total square feet of an asset class in a market.
Vacancy rates are typically measured for each asset class in a specific market. For example, office space in Austin, Texas or industrial space in Atlanta, Georgia.
Example
200,000 vacant square feet of industrial space
2,000,000 square feet of total industrial space
Vacancy rate is 10%.
Building Classifications
Class A, B, C
I get this question a lot: What is a Class, A, B or C building?
Although there are no formal definitions for Class A, B and C buildings, there general guidelines. Classes of buildings are determined according to age, amenities, features, quality, etc.
What constitutes a class A vs a class B building is very subjective and it relative to the inventory in the specific market.
For example, if the newest office space in a town in 5 years old, then that office space would probably be considered class A.
If there were 20 new office spaces developed in the past 5 years, that same office space may not be considered class A anymore.
Here is a general description for what constitutes each “class” for a specific asset:
Class A: Brand new, state of the art, all amenities, lease rates/ asking price are at the top of the market
Class B: Not brand new but not old. Class B buildings are still attractive but may lack some of the appeal and amenities a class A building has to offer. Asking price/lease rates will be middle of the market
Class C: Class C buildings need some work. They are in need of renovation and lack amenities. Asking price and lease rates are at the bottom of the market.
Conclusion
Although this blog can certainly not cover all the terms used in commercial real estate, I hope it can be a resource on some of the terms we use most frequently.
Have questions? Are there terms I didn’t cover you’d like to discuss? Let’s connect!
Emma McDaniel
VP, McDaniel and Company
864-576-4660, office
emma@mcdanielandco.com
