15 Commercial Real Estate Terms You Need to Know
Contributing Author: Levi Steier
As with any industry, Commercial Real Estate (CRE) vocabulary can sometimes be intimidating for the inexperienced. If you are starting a new business or considering investing in CRE, your interests would be best served by gaining some insider knowledge.
While you should always consult an experienced commercial real estate broker and retain their services, having a baseline understanding of some key terminology and concepts will improve your experience, make you more comfortable, and inform your decision making as you work toward a deal that is right for you and your needs.
- Expansion Rights – The legal right given by a landlord to a tenant to occupy additional leasable area in a building in the future.
While all businesses hope to grow, it is sometimes difficult to project the rate of growth and assess future needs. Additionally, most landlords want long-term leases. And of course, there is always a budget to consider. One way to mitigate risk, gain a level of cost certainty, and ensure the capability of expanding, is to negotiate expansion rights into the lease. This typically comes in one of two possible clauses:
Right of First Offer (ROFO)– A ROFO ensures that if new space becomes available, the landlord must inform you, their existing tenant, of the new opportunity and give you a chance to make an offer. The landlord can then accept, decline, or counter your offer.
Right of First Refusal (ROFR)– While it appears to be similar to the above-mentioned clause, a ROFR, on the other hand, provides that the landlord, if expansion space is available and has an offer in hand, must first give you the opportunity to lease space under the same terms.
- Parking Ratio – The parking ratio is the number of parking spaces a property has in relationship to the amount of square footage of a building.
This ratio is calculated by dividing the number of vehicle parking spaces into the building’s square footage and expressing the result per 1,000 square feet. For example, to determine the parking ratio of a retail plaza with 1000 parking spots and 100,000 square feet of shopping, you would divide 1000 by 100 for a parking ratio of 10 spaces per 1,000 square feet.
- Co-Broking – Landlords and property sellers often sign exclusive listing agreements with commercial real estate brokers to add horse power and increased exposure for their available properties.
As the exclusive broker with the assignment, they may offer a portion of their commission fee as incentive and cooperation to other brokers to assist in the process. This interaction is co-broking, and the two brokers share the commissions on the sale or lease.
- Gross Lease Vs. Triple Net Lease – These are simply lease formats to help the Landlord account and pay for the annual expenses of a property.
Gross Lease– A property lease where the landlord assesses the annual costs for expenses as a function of the annual rent. The Landlord accounts for these expenses monthly and uses the added rent to pay for all property costs directly. These include costs such as property taxes, building insurance, repairs and maintenance expenses, property management, snow removal, and lawn care, trash and janitorial services and even utilities in some instances.
Triple Net Lease (also known as NNN lease) – A property lease in which the tenant pays, in addition to rent, all expenses related to the operation of the property, including both fixed and operating expenses. As with other leases, it is important that each lease is reviewed to determine the expenses for which the tenant is responsible.
- Tenant Improvements– Improvements performed on the interior of a space or on the building or property, which can be paid for by the landlord and/or the tenant depending on the lease. If the improvement is determined to be specifically and directly related to the tenant’s sole need, most times the tenant would be responsible for making said improvement.
- Percentage Rent Lease– A lease in which a portion or all of the rent is based on the percentage of the sales volume made at the property. Depending on the location and products to be sold, a natural breakeven point is normally predetermined between Landlord and Tenant so only the portion of sales above this level are used to assess additional rent.
- Letter of Intent (LOI)– An informal, non-binding expression of basic business terms between landlord and tenant, which is used to indicate their intent to move forward with lease negotiations.
- Latent defect – A fault in the property that could not have been revealed through reasonable inspection or due diligence before the agreement was made.
- Referral Fee– This term applies to the fee, which is paid from one broker to another when they refer a client or assignment. Usually, it is a percentage of the receiving broker’s commission or a predetermined, fixed amount.
- Key Performance Indicator – A metric used to measure the performance of a property. CRE specific KPI’s include metrics such as Cap Rate, LTV, Debt Coverage Ratio, Internal Rate of Return, etc.
- Capitalization Rate– A percentage that relates the value of an income-producing property to its future income, expressed as net operating income (NOI) divided by purchase price. Commonly referred to as cap rate.
- Loan to Value (LTV)– The amount of money borrowed in relation to the total market value of the property. Expressed as the loan amount divided by the property value.
- Debt Coverage Ratio– Ratio of net operating income to annual debt service. Expressed as net operating income divided by annual debt service.
- Internal Rate of Return (IRR)– The percentage rate earned on each dollar that remains in an investment each year. The IRR of an investment is the discount rate at which the sum of the present value of future cash flows equals the initial capital investment.
- Net Operating Income (NOI)– The potential rental income plus other income, less vacancy, credit losses and operating expenses.
Regardless of whether you are looking to lease space for your business or you want to invest in your own property, it is imperative to have a basic understanding these terms and more as you work with your broker to achieve your goals. It is important for you to get the best deal possible and ensure you are on solid footing as you start your new venture. The ability to communicate more effectively on the topics above will not only speed up the process but also give you more confidence as you progress toward making a deal. With a basic understanding you can be more certain there are no blind spots in any negotiations and that you fully understand the terms of your contract once a deal is agreed upon.
Our brokers at NAI Platform possess extensive knowledge and experience of the industry’s intricate nuances, with a singular focus of working diligently to help our clients meet and surpass their goals.
For more information and expert guidance on your commercial real estate needs, please give us a call at NAI Platform or visit our website at www.naiplatform.com.
Levi Steier, Marketing Director
14 Corporate Woods Blvd.
Albany, NY 12211
Direct: 518-465-1400 Ext: 232
Fax: 518 465 1441
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