When buying or leasing investment properties, the commercial real estate vocabulary can be intimidating and quite challenging to navigate. Maybe you’ve heard of commercial real estate terms like “tenant improvement,” or “usable square footage,” but you don’t know what lies beneath. You might know some of the more common commercial real estate terms, like lease clause and net operating income, but when it comes time to talk to sellers and brokers and review leases, you may still feel under-informed.
If you are ready to dive into the real estate investment market, we’ve outlined 14 key commercial real estate terms that you’ll need to know. Knowing these commercial real estate terms will benefit your business, help you make informed decisions, and clarify any misconceptions about the terminology.
1. Right of Expansion (Pure Option)
Your tenant’s lease contract may include a Right of Expansion clause, or what’s also called a Pure Option, for future use. In such a case, you – the landlord – are responsible for providing additional available space for the tenant for the entire lease term, before the tenant actually needs the space. The tenant may or may not exercise the option to use the available space at any time during the lease.
The benefit to you is that, as the landlord, you can increase the rent based on the additional space, but you will need to keep an eye on this as it can cause problems later on if more tenants in the same building have expansion requests.
2. Option to Buy
If you’re leasing a fee-simple, single-tenant property to a tenant who wants to do a lot of build-outs or simply wants to buy the property at the end of the lease term, there may be an “option to buy” in the contract. If an option-to-buy lease clause exists, you will want to specify the terms under which the tenant can buy the property, as well as the price you expect, if you should decide to sell. Tenants usually perform the option-to-purchase at the conclusion of the lease.
3. Common Area Maintenance (CAM) Fees
CAM fees include all the costs of operating the commercial property. These fees include maintenance of shared areas: hallways, elevators, stairways, lobbies, public restrooms, parking lots, sidewalks, etc. Being a landlord, you will need to know how the CAM fee is calculated per tenant.
As different tenants will have different needs, you will also need to be able to communicate clearly how CAM fees will affect each individual lease contract. You could advise your tenants to think about what they would use from the common areas. Tenants could outline their expectations in a request for proposal document.
This way you’re demonstrating a very open and partner-like approach in helping each tenant be on the same page with you about all the details making up their individual lease agreements.
4. Usable Square Footage
Usable square footage is the amount of space that is being leased. It is the footprint that your tenant will take in a building. Usable square footage determines wall-to-wall space under the lease terms and includes the square footage of the place that is reserved for your tenant. Knowing this information will help you determine whether you have enough space for each of your potential tenants.
5. Rentable Square Footage
Rentable square footage includes the usable square footage plus some part of the square footage that will be shared among tenants. This may include bathrooms in hallways, lobbies, restrooms, elevators, or cafeterias. It may even cover spaces like maintenance and janitorial areas. Therefore, the rent amount is determined by the rentable square footage.
6. Parking Ratio
Remember that a lease involves all the available parking spaces reserved for tenant employees. To determine the parking ratio, take the total rentable square footage of a space, and divide it by the number of parking spaces. The lease contract should suggest how many parking spaces will be available for each tenant.
You can also advise your potential tenants to consult with their employees to learn how many of them drive to work, and how many would take public transportation. Small things like this will show your tenants that you are a good landlord who takes care of their needs.
7. Tenant Representative
The tenant representative is often the real estate agent who represents the tenant. He or she helps the tenant negotiate with you, the landlord. A tenant representative works on commission, splitting it with the landlord’s leasing agent, and acts as an intermediary between tenants and landlords. Moreover, the representative will try to resolve some issues between the tenant and the landlord.
As a landlord, you may mention the option of the tenant having their own representative just so there would be no awkward situations during the lease term. People tend to forget details, and having a tenant representative will make your life easier as you’re putting one extra degree of separation (and liability) between you and the tenant.
8. Landlord Representative (Leasing Agent)
The landlord representative works as the leasing agent. This agent represents the landlord and takes care of the landlord’s interests. When you become the owner of one or more commercial properties, your leasing agent is one of your best friends, so choose wisely.
The landlord representative’s first job is to get you the highest amount of rent with the least amount of expense. The holy grail deal is a triple-net (NNN) lease, of course! Your leasing agent also negotiates with the tenant’s representative on your behalf to draft an agreement that (ideally) optimizes rental costs, security deposit, tenant improvement allowances, etc.
Choosing a good leasing agent will help you get the best possible deal with every tenant. But be careful – you don’t want an overly aggressive deal where the tenant is cornered so much that the lease agreement becomes a legal liability for you.
Some landlords sign an exclusive listing agreement with a commercial real estate broker. As these brokers are there to hasten the rental process, they may invite other brokers to look over the property and to rent it. These other brokers, from your perspective, are co-brokers.
If your broker and his or her co-broker find a tenant who agrees to lease the property, the two brokers divide up the commission. Since the co-broker is not directly connected to you, you are not liable for paying extra commission for the co-brokers involvement.
Therefore, you should be perfectly fine with your broker reaching out for help from other brokers. It’s a benefit to you as you will have two brokers working together and you only pay for one broker.
10. Referral Fee
A referral fee is a fee paid from one broker to another when they refer a client. Usually, it is the percentage of the commission. This is how your broker works with a co-broker. The two of them usually agree to split the fee 50/50. You get double the help, they split the money, everybody’s happy.
There are three classes of buildings (A, B, and C), and you need to understand what these commercial real estate terms mean.
- Class A buildings are almost new, at a highly attractive location, and are known for good maintenance.
- Class B are average buildings with fewer amenities.
- Class C buildings are older than 20 years, and they need a lot of improvement and repairs.
Class A buildings will be the most attractive for tenants, but will usually be the most expensive to buy and to rent out. Class B buildings are usually cheaper to buy, have lower rent, and are less desirable. Class C are typically the cheapest buildings to buy, but you may face a lot of renovation expenses that may even include zoning and environmental issues and permit renewals.
It helps to understand these commercial real estate terms to ensure you are not paying more than you should for a building that doesn’t meet your perceived value or meet your expectations.
12. Rent Concessions
Rent concessions are allowances that permit discounted or free rent for a fixed period of time. Usually, rent concessions are linked to renovations or adaptations performed by the new tenant. It can also mean pushing forward the first rent payment, so the tenant is not facing extra expenses to move into your building.
You will need to be very wise here as you don’t want to get too far into concessions that would hurt your bottom line. You will also need to pay attention to the cash flow, as you may face tax liabilities, especially when postponing the first payment.
You will want your broker nearby to think through this carefully and make your property attractive to solid tenants without hurting profitability.
13. Tenant Improvements
“Tenant improvements” is a lease subset of rent concessions that you would discuss with the tenant. These improvements are changes made to the property by the tenant. Your tenant may decide to alter the property and make some changes that suit the business’s needs better. Such improvements may include flooring, ceilings, painting etc., and should be negotiated before signing the lease.
You will want to have counter-offers for all the improvements, so you know the rent concessions will not be overly expensive for you. In some cases, you may be better off doing tenant improvements yourself and flipping the rent toward a higher number, rather than accepting a rent reduction because of tenant-performed improvements.
14. Letter of Intent (LOI)
This is a written document that reinforces the tenant’s commitment to lease the property. The Letter of Intent (LOI) includes the terms of the lease such as negotiations, concessions, and timeframes and it is signed before the lease agreement.
If you are presented with an LOI, make sure your broker quickly evaluates how serious the LOI really is. In some cases, co-brokers will hasten the Letter of Intent without checking if the tenant is really a solid pick. It will be up to you and your broker to leave no stones unturned and make sure you are closing a deal with the right tenant.
Sometimes, you will have more than one Letter of Intent. This is actually preferred so that you can pick which tenant you like the most. Bottom line, it’s your place you’re renting, and you should have the option to choose.
If you are purchasing a NNN lease property, you will be the one presenting the LOI. In this case, a Letter of Intent is a non-binding, good-faith proposal by you, the buyer, to the seller. This document sets the goals for an official offer to purchase. It is a time-saver that crystalizes the prospective transaction details, minimizes misunderstandings, and documents progress toward an official offer. It is often used as a tool for the property identification process in a 1031 exchange and for NNN investments.
To Wrap it Up – Knowing Key Real Estate Terms Benefits Your ROI
Getting into commercial real estate as a landlord can be quite scary if you are not familiar with the basics, which include the key real estate terms and their meanings. As a new investor, absolute NNN lease property investing can be the easiest and often most lucrative route, as NNN leases tend to be straightforward and the tenant pays for everything – taxes, insurance, and CAM. You simply collect the rent.
However, whether you purchase a fee-simple, single-tenant property, a ground lease, or a multi-tenant property investment, it is very important that you educate yourself on the basics of the process and working with real estate brokers and tenants. Working as a team to make sure there are no blind spots in any negotiation and any lease contract you sign is imperative.
At Westwood Net Lease Advisors, we provide an evaluation and risk-tolerance assessment, explore properties that fit your investment criteria based on actual numbers rather than guesswork, and evaluate tenant financials and credit ratings to find the property and tenant type that’s right for you. We also work with you to craft the Letter of Intent (LOI) and analyze/negotiate lease details, source legal and financial services, and more – all at no cost to you. Our buyer advisors are here for you every step of the way – from initial inquiry all the way to closing. Feel free to reach out for a no-obligation, free consultation to get started. 314-997-5227.