From a business owner looking to purchase a building to someone who has come across some extra money and is looking for an investment, seven terms are especially important to understand when considering entering the world of commercial real estate. These terms are common in conversation, blog articles and in contracts, which can be long, confusing and laden with industry lingo. So, along with knowing the seven types of commercial real estate and the three common types of leases, grasping this foundational jargon will help when it comes down to making a deal.
The capitalization rate (cap rate) is a mathematical formula that determines the expected rate of return on a commercial real estate investment. Several methods exist, but the most popular is dividing the property’s net operating income (NOI) by its market value.
Net operating income is a pre-tax-and-interest measurement of the annual revenue generated by a property after deducting most operating expenses. A positive NOI shows that the property produced a profit from operations. Net operating income in other industries is commonly referred to as “earnings before interest and taxes” (EBIT).
Because a lot of space in commercial real estate is taken up by elevators, hallways, stairs, bathrooms and other areas that don’t function as an office, usable square footage (USF) shows how much room is actually available to be used as a workspace.
If USF is a measurement of available workspace in a building, rentable square footage (RSF) includes all those shared areas like hallways, lobbies and restrooms. Why is it so important to understand the difference between USF and RSF? For one, they each reveal something different about the amount of space there is in which to work. But, more importantly, rent is almost always calculated on RSF.
Common area maintenance (CAM) is the amount a tenant of a building is responsible to pay to help with the upkeep of the building. Each lease handles this amount differently.
The escalation clause explains the amount that rent will increase annually. This may be based on property taxes, operating expenses or even the Consumer Price Index (CPI).
An allowance for improvements is typically negotiated up-front when a lease is signed. Tenant improvements include any custom interior finishes or enhancements requested by lessees. Like CAM, the allowance and conditions for tenant improvement vary by lease.
Having an understanding of these common terms will help anyone navigate the often-overwhelming world of commercial real estate. But for any other commercial real estate questions or needs, contact Chris Falk.