If you’re new to commercial real estate there are several essential terms found in commercial loans you must know in order to ensure you fully understand your rights.
Here is a list of 10 common real estate terms every investor should know.
1. The Right Of First Refusal
Occasionally it happens that a landlord has additional space available for lease. Since space is always a prime commodity, some tenants will insist on a right of first refusal clause in order to ensure they are offered the property before anyone else.
This can be invaluable for encouraging tenants who anticipate a large amount of growth in the future to remain as tenants.
The right of first refusal can also refer to purchase rights, where the owner allows the tenant the right to purchase a property before it is offered to anyone else.
If you a sign a lease that includes a right of first refusal clause, your landlord is required to offer you additional space to lease before offering it to the general public. This gives you the opportunity to lease more office space in an in-demand building if it becomes available and can be highly beneficial if you anticipate major growth in the coming years.
In either case, whoever holds the right to refusal is not obligated to carry through; the owner is also not obligated to rent space or sell the property.
2. Option Тo Purchase
Option to purchase clauses simply gives a tenant the option to purchase a property that is being leased. It specifies the price and the terms of the lease. This can be advantageous to both sides, depending on the property and market conditions at the time the lease is signed.
It is important to note that when an option is included in a lease, the lessee must pay for the option of signing the contract. However, the receipt of money does not mean the seller relinquishes ownership of the property.
The seller retains full ownership of the property and any income that may result from the property.
Some lessees prefer acquiring the option to purchase a property early on, for several reasons. One, an option to buy can lock in a favorable price, particularly if prices in the area or for this market type are steadily rising.
Second, options can be sold to another party for a higher price than was paid, at any time until the end of the option period.
3. Usable Square Footage
Usable square footage is the actual space a tenant occupies when leasing property. It includes all of the area leased by a tenant, including hallways and bathrooms, if they are not shared with other tenants. It does not include common areas shared by all tenants such as stairways, lobbies, or shared hallways.
4. Rentable Square Footage
Rental square footage refers to the usable square footage plus a percentage of the building’s space shared by all tenants. The amount you pay monthly always includes a portion of the shared spaces in addition to the usable square footage.
5. Parking Ratio
Rather than receive set parking spaces, tenants receive a ratio of parking spaces depending on the number of usable square feet. A parking ratio of 4:1 means four spaces for every square foot of space you lease are reserved for your use.
6. Load Factor
The load factor is used to calculate the exact common area footage each tenant should be required to share. It is calculated by figuring out exactly how much total area a building has. Next, determine the amount of shared space; deduct that number from the usable square footage.
Next, divide the rentable square footage by the usable square feet; this will give you the load factor.
7. Common Area Maintenance
It’s quite common for tenants in a multi-tenant building to pay common area maintenance fees, known as CAM. There are two types of CAM fees: variable and fixed. The CAM fee is meant to cover repairs and property maintenance, landscaping, security, and salary of any staff needed to manage the property.
Each tenant pays a percentage of the total CAM expenses, depending on how much space they occupy in the building. So for example, if the cost of maintaining the common areas adds up to $10,000 a month and you occupy a fourth of the rentable square footage, you would be required to pay $2,500 a month.
8. Request For Proposal
A request for proposal is the first step a tenant takes when considering negotiating a lease with you, the owner. The prospect views the property and determines what considerations need to be addressed in order for them to take the property. It is also where a tenant will ask for any monetary breaks or incentives.
Rather than verbally hammer out the details, a request for proposal gives you an idea of what a tenant wants before they start the negotiation process in earnest. An RFP forms the basis for a lease agreement and therefore should be carefully reviewed.
9. Escalation Clause
Many commercial leases include a clause that allows the owner to raise the lease after a specified period of time. This is called an escalation clause, and it may take place yearly, every three years, or more. Escalation causes may be based on a specific CPI, or an increase in operating or property taxes.
In order to control expenses, some tenants prefer to negotiate a fixed instead of a variable increase based on the CPI or another factor.
10. Covenants
Covenants are a promise to do – or not do- something in relation to a property. If they require a tenant to do something in relation to the property, then they are termed affirmative; negative covenants require tenants to refrain from a specified activity.
Investors need to pay close attention to covenants, since they can seriously restrict the use of a property, either in appearance or use.
