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Commercial Real Estate Terms and Definitions

Want to know the difference between a modified gross lease and a full service lease?  Find some popular and necessary to know commercial real estate terms and definitions below:

A

Absorption – The amount of inventory or units of a specific commercial property type that become occupied during a specified time period (usually a year) in a given market, typically reported as the absorption rate.

Add-on factor – The ratio of rentable to useable square feet. Also known as the load factor and the rentable-to-useable ratio. Also see efficiency percentage. Formula: Add-on factor x Rentable square feet = Useable square feet

Assignment – This refers to the ability to transfer an entire space along with all the obligations of a particular lease agreement to another entity, which can be an individual or a business. If you have a company that might be bought out, it is crucial that you prepare this in advance.

Average annual effective rate – The average annual effective rent divided by the square footage.

Average annual effective rent – The tenant’s total effective rent divided by the lease term.

B

Base – (in lease terminology) A face, quoted, dollar amount representing the rate or rent in dollars per square foot per year and typically referred to as the base rate.

Base rent – The minimum rent due to the landlord. Typically, it is a fixed amount. This is a face, quoted, contract amount of periodic rent. The annual base rate is the amount upon which escalations are calculated.

Base Year – Landlords will estimate a specific portion of their lease rate that is in fact operating expenses. The tenants is then given this amount for a year, which takes effect when the lease is signed. Any expenses that go beyond this amount, will be payable directly by the tenant. These amounts are based on a pro-rata basis for every tenant in the building.

Build-Out – This is the interior are of construction in a specific tenant’s rented space. This includes new construction areas or rebuilding of existing areas.

Building Standard – A list of materials and finishes typically used by the Landlord in all of their build-outs, repairs or restorations of their tenant’s suites.

C

Capital expenditures – Property improvements that cannot be expensed as a current operating expense for tax purposes. Examples include a new roof, tenant improvements, or a parking lot—such items are added to the basis of the property and then can be depreciated over the holding period. Distinguished from cash outflows for expense items such as new paint or plumbing repairs (operating expenses) that can be expensed in the year they occur. Also see operating expenses.

Capitalization rate (Cap rate) – A percentage that relates the value of an income-producing property to its future income, expressed as net operating income divided by purchase price. Also referred to as cap rate.

Certificate of Occupancy – This needs to be presented to the landlord by the city building department Presented by city building department after improvements to a property have been completed.

Class A, B, or C – This is used to classify the quality of a specific building. It is generally based on the rates of the rent, as prices usually indicate the quality of the property.

Commercial real estate – Any multifamily residential, office, industrial, or retail property that can be bought or sold in a real estate market.

Common area – For lease purposes, the areas of a building (and its site) that are available for the nonexclusive use of all its tenants, such as lobbies, corridors, and parking lots. (Real Estate Information Standards)

Common area maintenance (CAM) – Charges paid by the tenant for the upkeep of areas designated for use and benefit of all tenants. CAM charges are common in shopping centers. Tenants are charged for parking lot maintenance, snow removal, and utilities.

Contiguos Office Space – Office spaces that are next to each other (adjacent) or have a common wall area

Contract rent – The total rental obligation, expressed in dollars, as specified in a lease. Also known as base rent. (Real Estate Information Standards)

Cost of occupancy – Expenditures that are required to assume and maintain occupancy of a space. Such expenditures include rent and/or mortgage payments, and recurring costs, such as real estate taxes, repairs, operating expenses, and other outgoings directly resulting from the use of the property. (Encyclopedia of Real Estate Terms 2nd Edition, Damien Abbott)

Cross-over (office use) demand – Industrial space that is used as office space in order to lower the rental rate of a property. Also known as flex space.

D

Demising Wall – This wall separates the area of the tenant from another’s, and in many cases this wall can be made from the floor to the roof.

Due diligence – The process of examining a property, related documents, and procedures conducted by or for the potential lender or purchaser to reduce risk. Applying a consistent standard of inspection and investigation one can determine if the actual conditions do or do not reflect the information as represented.

E

Effective rate – An amount after a base amount has been adjusted for concessions, allowances, and costs.

Equity lease – A type of joint venture arrangement in which an owner enters into a contract with a user who agrees to occupy a space and pay rent as a tenant, but at the same time, receives a share of the ownership benefits such as periodic cash flows, interest and cost recovery deductions, and perhaps a share of the sales proceeds.

Estoppel Certificate – This is a document signed by the Tenant that confirms they are the Tenant, that their lease is legitimate, and the amount of any security deposit the Landlord is holding. It is usually required to be signed by the Tenant when an owner sells the property, or is refinancing their debt on the property.

Exchange – Under Section 1031 of the Internal Revenue Code, like-kind property used in a trade or business or held as an investment can be exchanged tax-deferred. Under a fully qualified Section 1031 exchange, real estate is traded for other like-kind property. All capital gains taxes are deferred until the newly acquired real estate is disposed of in a taxable transaction. The underlying philosophy behind the deferral of capital gains taxes is that taxation should not occur as long as the original investment remains intact in the form of (like-kind) real estate (like-kind refers to real property as such, rather than the quality or quantity of property).

Executive Suite – An office within an office. Usually less than 200 square feet. In addition to the space, the tenant may receive services such as secretarial, reception, copy, fax, and phone. The price is usually 2 to 4 times typical space. Great option for one or two man shows or startups. Lease terms may be as short as month to month.

F

Fixed expenses – Costs that do not change with a building’s occupancy rate. They include property taxes, insurance, and some forms of building maintenance.

Fixed lease – A lease in which the lessee pays a fixed rental amount for the duration of the lease.

Flex space – Space that is flexible in terms of what it can be used for (for example, space that could be utilized for industrial or office activities). Also see cross-over (office use) demand.

Free rent – See rent concessions.

Full Service Lease – A term used to describe a lease in which the stated rent amount being paid to the Landlord includes all the expenses of the building (ie:electricity, water, gas, janitorial, real estate taxes, maintenance, insurance, etc..). However, the name “Full Service” is really a misnomer because the tenant is usually responsible for any operating expense or tax increases above their Expense Stop (AKA Base Year). The tenants portion is called the Pass-through cost.

G

Gap analysis – An evaluation of the difference in the demand and supply of space (measured in terms of square footage) for a particular type of commercial property in a given market area where gaps are expressed as the amount of square footage demanded less the amount of square footage available in a given time period. Note that if demand exceeds supply, the gap will be positive. A positive gap indicates that potential opportunities exist for successful commercial real estate transactions. However, transactions might be avoided when supply exceeds demand (or when a negative gap occurs), as there is an oversupply of available space in the market.

Geographic submarket – The total number of households or housing units within a given area as defined by tenure, income, and other socio-economic attributes that are known to exist or estimated to be within specific geographic units or divisions (for example, in various census tracts).

Gross area – The entire floor area of a building or the total square footage of a floor.

Gross leasable area (GLA) – The total floor area designed for tenant occupancy and exclusive use, including basements, mezzanines, and upper floors, and it is measured from the center line of joint partitions and from outside wall faces. GLA is that area on which tenants pay rent; it is the area that produces income.

Gross lease – A lease in which all expenses associated with owning and operating the property are paid by the landlord. Also see net lease.

Ground lease – A lease of the land only. Usually the land is leased for a relatively long period of time to a tenant that constructs a building on the property. A land lease separates ownership of the land from ownership of buildings and improvements constructed on the land.

H

Highest and best use – The reasonably probable and legal use of vacant land or an improved property, which is physically possible, appropriately supported, financially feasible, and that results in the highest value. [Appraisal Institute]

Holding Over – A situation whereby a tenant is still occupying the space after their lease has expired. It can occur with or without the landlords consent. Often, hold over periods are pre-stated in the lease, and the tenant will incur a rent increase (i.e. 150% of current rate) until they vacate or renegotiate the lease. It causes the Tenant to agree on renewing or vacate as the cost of making no decision could be excessive.

HVAC – Heating, Ventilating and Air Conditioning.

I

Inventory – The supply or stock of a given commodity or a listing thereof.

L

Landlord – The lessor or owner of the leased property.

Landlord-paid tenant improvements (LPTI) – The total cost (outlay) of necessary tenant improvements paid by the landlord netted against any contribution made by the tenant.

Lease – A contract that creates the relationship of landlord and tenant. A contractually binding agreement that grants a right to exclusive possession or use of property, usually in return for a periodic payment called rent. (Encyclopedia of Real Estate Terms 2nd Edition, Damien Abbott)

Lease buyout – The process by which a landlord, tenant, or third party pays to extinguish the tenant’s remaining lease obligation and rights under its existing lease agreement.

Lease Commencement Date – The date upon which the lease commences and the obligations of the parties begins (see also “rent commencement date”).

Leasehold interest – The value (to the tenant) of the lease. The value of the leasehold interest is determined by present value of the difference between market rent and the contract rent.

Lessee – The person renting or leasing the property. Also known as a tenant.

Lessor – The person who rents or leases a property to another. Also known as a landlord.

Letter of Intent – A document that outlines the general terms of a proposed lease or purchase. Commonly called the LOI. It becomes the basis from which a formal lease or purchase document is written. These may or may not be binding between the parties, depending on language used. A more thorough Letter of Intent provides the parties with a more clear understanding of what they will agree to in the formal lease or purchase contract.

Load factor – The ratio of rentable area to useable area. The load factor is a gauge by which a user can evaluate different sites with comparable rents. It is also known as the add-on factor. Formula: Load factor = Rentable square feet/Useable square feet

Location analysis – The process of evaluating whether a general location meets the requirements of being both possible and practical as defined on the basis of technical and functional components.

M

Market analysis – The process of examining market supply and demand conditions, demographic characteristics, and opportunities; identifying alternative locations/sites that meet specific objectives or satisfy various criteria; and assessing the financial feasibility of those locations/sites to facilitate decision making regarding the commercial potential or suitability of various locations/sites to support a given activity or use.

Market area – A geographical area in which supply and demand operate to influence the course of industrial and commercial activities, for example, a Metropolitan Statistical Area (MSA).

Market dynamics – In reference to changing market conditions and the underlying processes responsible for creating change and defining/redefining interrelationships amongst components in an economic system (consider the change in price levels of a given commodity as an outcome of the forces and interplay of supply and demand).

Market feasibility – Pertaining to the evaluation or selection of a site or an analysis of a site’s highest and best use. Also see feasibility analysis.

Metropolitan Statistical Area (MSA) – Generally, the area in and around a major city. The Office of Management and Budget (OMB) defines an MSA as having one of the following characteristics: a city with a population of at least 50,000, or an urbanized area with a population of at least 50,000 with a total metropolitan population of 100,000.

Modified Gross Lease – A modified gross lease is similar to a full service gross lease, except that some of the base services are not included by the landlord (taxes,  maintenance, insurance, and utilities).  The most common type of MG lease excludes maintenance, janitorial, and electrical.

Moving allowance – A specified dollar amount paid by the owner to cover, in part or in whole, tenant moving expenses. Also known as owner’s moving expense.

Multiple-use office space – Office space that can be used for a variety of purposes; sometimes referred to as generic office space.

N

Net lease – A lease in which the tenant pays, in addition to rent, all operating expenses such as real estate taxes, insurance premiums, and maintenance costs. Also see gross lease.

O

Occupancy cost – The actual dollars paid out by the tenant to occupy the space. It can be expressed in either pre-tax or after-tax dollars.

Office –
Low-rise – Fewer than seven stories high above ground level.
Mid-rise – Between seven and twenty-five stories above ground level
High-rise – Higher than twenty-five stories above ground level.

Office property – A commercial property type used to maintain or occupy professional or business offices. Such properties typically house management and staff operations. The term office can refer to whole buildings, floors, parts of floors, and office parks. Office space that can be used for a variety of purposes is sometimes referred to as generic office space. Office properties may be classified as Class A, B, or C. Class A properties are the most functionally modern. Properties Classed B and C in the same market typically command lower rents because they are older and in need of modernization. They may not be as efficient or desirable as Class A properties because their design or condition causes functional problems.

Operating expense stop – A negotiable amount at which the owner’s contribution to operating expenses stops. It also can be stated as the amount above which the tenant is responsible for its pro rata share of operating expenses.

Operating expenses – Cash outlays necessary to operate and maintain a property. Examples of operating expenses include real estate taxes, property insurance, property management and maintenance expenses, utilities, and legal or accounting expenses. Operating expenses do not include capital expenditures, debt service, or cost recovery.

Oversupply – In reference to commercial real estate, oversupply is a stock or supply of a given commercial property type that is greater than that which can be cleared under prevailing prices levels and market conditions (for example, excess supply). Also, a phase of the real estate market cycle denoting that period of time in which commercial real estate markets become saturated with units due to overbuilding.

P

Parking Ratio – The number of parking spaces divided by the total size of the building. A ratio of 1:250 means tenants are allowed one parking space for every 250 square feet in the building. The lower the ratio, the more parking spaces there are.

Pass Throughs – This is the expenses that are associated with the lease that the landlord “passes through” to allow for certain increases in the expenses of the building.

Percentage lease – A lease in which the rent amount is based on a percentage of gross sales (monthly or annually) made by the tenant.

Percentage rent – The additional rent (over a base amount) that is paid by tenants to owners on tenant sales over a specified dollar amount. It is frequently found in retail leases. Also known as overage rent.

Pipeline information – Information (substantiated and rumored) regarding new inventory that is in the process of being added to the market by a specified forecast period.

Prestige and property classes – In reference to the recognition that various levels of status may be assigned to commercial properties as defined by user needs, the quality of a property and its amenities in relation to site factors, and its general location, suggesting the division of properties into distinct classes.

R

Rent concession or abatement – A period of free rent given to the tenant by the lessor.

Rent escalators – Items specified in a lease such as base rent, operating expenses, and taxes that may increase by predetermined amounts at stated intervals or by a constant annual percentage. Also see index lease and expense stop.

Rentable area – The computed area of a building as defined by the guidelines of Building Owners and Managers Association (BOMA) and typically measured in square feet, including both core/structure and useable area. The actual square foot area for which the tenant will pay rent. It is the gross area of an office building, less uninterrupted vertical space (such as stairways and elevators). Unlike useable area, rentable area includes common areas such as lobbies, restrooms, and hallways as well as the measurement of structural columns and architectural projections.

Rentable-to-useable ratio – Defined as rentable area divided by useable area. Also known as the add-on factor or load factor. Also see efficiency percentage.

Replacement cost – The estimated cost to construct, at current prices, a building with utility equivalent to the building being appraised, using modern materials and current standards, design, and layout. [Appraisal Institute]

S

Sale-leaseback – A leasing and financing strategy in which a property owner sells its property to an investor, then leases it back. This strategy frees capital that otherwise would be frozen in equity.

Site analysis – The identification and evaluation of a site or sites to satisfy a given use or objective.

Site factors – Site-specific factors, features, conditions, or attributes which are important in the analysis or evaluation of a location/site (including relative location, visibility, aesthetics, landscaping, condition of existing structures, regulatory mechanisms, and lot size).

Site selection – The process of determining the best site for a specific use.

Space market – The supply and demand for the use of physical space.

Step-up lease – A lease in which the rental amount paid by the lessee increases by a preset rate or set dollar amount at predetermined intervals. A step lease is a means for the lessor to hedge against inflation and future maintenance or operational expenses.

Sublease – A lease in which the original tenant (lessee) sublets all or part of the leasehold interest to another tenant (known as a subtenant) while still retaining a leasehold interest in the property. Also known as a sandwich lease due to the sandwiching of the original lessee between the lessor and the subtenant.

Submarket – A segment or portion of a larger geographic market defined and identified on the basis of one or more attributes that distinguish it from other submarkets or locations.

Supply – The amount of property that will be made available for sale or rent at a given price or rental rate.

Synthetic lease – A leasing and financing strategy whereby the terms of the lease under specific Financial Accounting Standard Board guidelines change the lease obligation from a capital lease (long-term lease on the company’s balance sheet) to an operating lease (short-term lease on the company’s balance sheet).

T

Tax savings (annual expense) – Entry on the tenant’s Cash Flow Form. All annual expenses incurred by the tenant are tax deductible. The tax savings are calculated by multiplying the annual deduction by the tenant’s tax rate.

Tax savings (capital expenditure) – Entry on the tenant’s Cash Flow Form. It refers to any tax savings associated with any capital expenditure by the tenant in terms of the site or major, unusual business expenses incurred to make the new office efficient for the business. The amount of tax savings is calculated by multiplying the annual deduction amount by the tenant’s tax rate.

Tenant – A person or entity who has possession of the property though a lease. A tenant also may be referred to as a lessee.Tenant improvements
Preparation of leased premises prior to or during a tenant’s occupancy, which may be paid for by either the landlord, the tenant, or both.

Tenant-paid tenant improvements (TPTI) – The total cost (outlay) of necessary tenant improvements paid by the tenant netted against any allowance provided by the landlord.

TI allowance from owner – Entry on the tenant’s Cash Flow Form. A specified amount of money the owner will pay for tenant improvement.

Total effective rate – The rate per square foot paid by the tenant over the entire period analyzed.
Formula: Total effective rate = Total effective Rent/Square footage rented

Total effective rent – The total dollar amount (cash flow) that the tenant actually will pay out over the entire period analyzed.

Total existing inventory – In reference to commercial real state, it is existing and currently available supply or stock as represented by the total number of units or total amount of space available of a specific commercial property type in a given market at a particular point in time.

Total forecast supply – Total existing inventory plus forecast planned additional inventory minus forecast planned removed inventory for a specific commercial property type in a given market area.

Total supply of commercial real estate – Refers to all existing space vacant or occupied, built, forecasted, or demolished, for a particular market area for a specific period of time.

Triple Net Lease (NNN) – Generally refers to the requirement for the lessee to pay for its share of the property’s taxes, insurance and maintenance.

Turnkey – This is an entire build-out of a premises leased by a tenant, according to the tenant’s specifications at no additional cost to the tenant.

U

Useable area – Rentable area, less certain common areas that are shared by all tenants of the office building (such as corridors, storage facilities, and bathrooms). Also defined in office buildings as the area that is available for the exclusive use of the tenant. Useable area = rentable area × building efficiency percentage.

V

Vacancy – The number of units or space (of a specific commercial type) that are vacant and available for occupancy at a particular point in time within a given market (usually expressed as a vacancy rate).

Vacancy rate – The percentage of the total supply of units or space of a specific commercial type that is vacant and available for occupancy at a particular point in time within a given market.

W

White Box – The interior condition of either a new or existing building or suite in which the improvements generally consist of heating/cooling with delivery systems, lighting, electrical switches and outlets, lavatories, a finished ceiling, walls that are prepped for painting, and a concrete slab floor. Also called a “vanilla box”