15 Commercial Real Estate Terms You Need to Know
15 Commercial Real Estate Terms You Need to Know
Buying or Leasing Commercial Real Estate is one of the biggest expenses incurred by your business. When leasing or buying commercial real estate, the vocabulary can be intimidating and confusing at first. Whether you need a small retail shop or a large warehouse, a basic understanding of common Commercial Real Estate industry terms used will help you better understand the process.
If you are ready to dive into buying or leasing commercial real estate, we’ve outlined key commercial real estate terms that you’ll need to know. Becoming familiar with some basic terminology will untangle the confusing process and help you make informed decisions.
First things first, what is Commercial Real Estate?
Commercial Real Estate includes all buying, selling, and leasing of any Commercial property that is used or zoned for purposes such as Retail, Industrial, Office, Medical, Multifamily of 4 units or more, and Commercial Land.
What are the different types of Leases?
FSG- Full-Service Gross Lease:
A Full-Service Gross lease includes the base rent and other building operating expenses, including janitorial service, utilities, maintenance and repairs, building insurance and property tax, and common area maintenance (CAM). None of the additional services are charged as additional rent. You pay a base rent amount only.
MG – Modified Gross Lease:
A Modified Gross lease is essentially the same as a FSG lease where the tenant pays base rent, but with an MG lease, the tenant also pays additional costs associated with the property such as: janitorial, a utility bill(s), or garbage.
NNN – Triple Net Lease:
A Triple Net Lease (NNN) is an agreement where the tenant pays their proportionate share of building expenses called Nets and include real estate taxes, building insurance, and Common Area Maintenance (CAM). The tenant pays for the above named monthly NNN expenses, plus base rent, plus utilities.
This is a calculation used in buildings that have common areas such as hallways, bathrooms, entry, common conference rooms to determine how much of the building these areas occupy. That percentage of the building is called a load factor. In buildings where tenants also use a common area, there is a load factor added onto the square footage of space they occupy. Commonly, 10% - 20% is added on to the “Usable Square Feet” (or actual) square footage to come up with a “Rentable Square Feet” (Usable + Load Factor). Load factors are not used in buildings that don’t have a common area such as Retail and Industrial spaces, but is more often found in Office or Medical space.
The formula is: Usable Square feet x Load Factor = Rentable Square Feet
For example, if a tenant measures 1,000 SF of space they are renting, but the load factor in the building is 15%, the tenant will pay rent for 1,150 SF (1,000 USF *1.15 = 1,150 RSF) to include their proportionate share of the common areas of the building.
TI - Tenant Improvement:
TI (tenant improvements) is the customized alterations made to rental space as part of a lease agreement, in order to configure the space for the needs of that particular tenant.
Tenant improvements (TI’s) are negotiated by your broker to determine how much the Landlord will pay or contribute, and how much the tenant will pay or contribute towards the TI.
There are many variables that will determine how much the Landlord will pay including Landlord financial ability, asset type, lease length, as well as other factors the tenant is attempting to negotiate on such as free rent or reduced rent.
1st vs 2nd generation space:
A 1st generation space is either a space that has not been built out for the specialty use, or is an empty shell without walls, drop ceilings, flooring, HVAC, electrical, or plumbing.
2nd generation space, or “2nd gen”, is commonly used to describe specialty use TI that is already built out by a previous tenant such as a restaurant, hair salon, or medical space. For tenants on a budget, it is often cost prohibitive to build out a specialty use TI into a 1st generation space, and is less expensive to find a 2nd generation space for specialty use tenants which only requires cosmetic improvements.
Raw shell vs Vanilla shell:
The term Raw shell refers to a space that consists of a concrete or dirt floor, wall studs but no insulation or sheet rock, exposed ceiling with or without electrical brought into the space, and often without plumbing or HVAC. This is often found in new construction buildings.
The term Vanilla Shell refers a basic structure built out in the rental space. This typically includes sheetrock and taped walls ready to paint, electrical panel, a concrete floor, construction lighting, HVAC without duct work, stubbed plumbing but no fixtures.
Net operating income (NOI) is a calculation used to analyze the profitability of income-generating Commercial real estate investments. NOI equals revenue minus all operating expenses that are not reimbursed to the landlord.
A Cap rate (or Capitalization Rate), is a percentage measurement used to compare the rates of return on commercial real estate properties. Cap rates are calculated by dividing the property’s net operating income (NOI) from its property asset value.
A parking ratio is the total ratio of the rentable square footage of a building to the total number of parking spots of that building. This ratio is a calculation of parking spots per 1,000 square feet of space leased. For example, a parking ratio of 1:1000 (one per thousand), this means that you will be allotted 1 parking stall for every 1,000 SF of space leased. In the example of a parking ratio of 3:1000, you would lease 1,000 SF of space, and you would be allotted 3 parking spaces.
The vacancy rate is the percentage of all available square footage in a Commercial rental property that is vacant or unoccupied at a particular time. On a larger scale, vacancy rates are used to measure the health of a rental market.
Overall Vacancy rates of 10 – 12% indicates a healthy balance of Tenants looking for space, and vacant space available. If rates are over 12%, it becomes a Tenant market with more space available than tenants. Tenants often have more negotiating power in this environment. Vacancy rates under 10% are a Landlord’s market, where there are fewer options to lease than there are tenants. Landlords often have a negotiating advantage when vacancies are in the single digit range.
Class A, B, C Buildings –
Although there is not a clearly defined differentiation between A, B, and C properties, and it is rather subjective, the following is a lose delineation between the three types.
Class A buildings are considered a top-tier property. These properties are typically newly constructed and/or well maintained, are multiple stories high with a retail component, and command top dollar whether leasing or purchasing.
Class B buildings are a step-down from Class A buildings. They are typically older or and may have once been a Class A property but now have older surface materials. They could also be a smaller new construction building (under 4 stories) and without a retail component.
Class C buildings are typically older, will show visible signs of deterioration and deferred maintenance.
At Commercial Real Estate NW, we are committed to providing our clients with world-class service, experience, and expert industry insights to help generate substantial returns. Our team’s collective success over the years has been built on this formula. We look forward to the opportunity to help you reach your commercial real estate buying, selling, or leasing goals.