27 Commercial Real Estate Terms You Should Know

December 2, 2020 Don Catalano Don Catalano

Commercial real estate can be complex. It also comes with a set of key terms that you should know. Whether you are new to commercial real estate, or just need a refresher, here are 27 commercial real estate terms to get familiar with: 


1. Assignment

Some leases contain assignment language that gives you the right to find another tenant to take over your lease in the event that you want to leave before it ends. This is generally more favorable to you than subleasing out your space since when you assign a lease someone else actually takes responsibility for it and for the relationship with the landlord. Read the language carefully, though, since the lease assignment will usually be subject to the landlord's approval. Frequently, you will also still have the responsibility to pay the remainder of your lease if the assignee defaults on their obligations.

 

2. Base Year

Some full-service leases have provisions that require you to pay for changes in the building's operating expenses over time. A base year provision takes a specific year -- frequently the year you signed your lease, or the first full year thereafter -- and makes its expenses what the landlord will cover for the future, leaving you to pay any expenses. For example, if your base year is 2019 and the building's operating expenses were $17.75 per square foot, that's what the landlord would pay for you. So, if the expenses in 2020 are $17.50, you wouldn't have to pay anything extra, since the $17.50 is less than the $17.75 that the landlord paid in the base year.  However, if expenses jump to $19.25 in 2021, you will have to pay the $1.50 difference between 2021's expenses and the $17.75 that was set back in the base year of 2019.

 

3. CAM (Common Area Maintenance)

CAM -- which is short for common area maintenance -- is a charge that some leases require you pay to defray some or all of the cost of running the building's "common area." This generally includes anything that serves shared areas of the building (like lighting the halls, cleaning the bathroom, or re-striping the parking lot or garage) or that is involved in shared amenities or services of the building (like a water or garbage bill that isn't broken out by suite).  CAM charges can also include management and administrative fees.

 

Usually, the landlord will prepare a CAM budget at the beginning of the year, proposing what they think the year's CAMs will cost. Then, they will bill you monthly for your share of the CAM, usually tied to your pro-rata share of the building's leasable area.  At the end of the year, they will true up what they billed you and they actually paid through the CAM reconciliation process.  Don't be surprised if you end up owing the landlord some money for a shortfall, or if they end up sending you a check to compensate you for over billing if expenses fall short of expectations.

 

When you have a lease that includes CAM charges, read its provisions carefully. Technically, CAM reimbursements are separate from reimbursements for taxes, insurance, or capital expenditures. However, many landlords bundle them together, so the only way to be sure what you will have to pay is to understand each individual lease or landlord proposal separately.

 

4. CAM Audit

Many leases contain language that allows you to do a CAM audit and see if what the landlord is charging you actually lines up with what they are paying. As you can imagine, calculating CAMs can be complicated and it's easy to make a mistake.  If your lease allows you to request an audit, you can have the landlord provide a detailed accounting of what actually went into the CAM, and potentially give you a refund if you were overcharged. Know, however, that you may have to pay the cost of the audit if it does not uncover material overcharges. Also, be aware that you could end up owing more money if it turns out that you were undercharged.

 

5. Common Area

The common area of a building refers to parts of that building that aren't in any specific tenant's space but are, instead, shared among all tenants. Common areas include hallways, lobbies, restrooms, and amenity spaces like shared fitness centers or conference facilities. In most buildings that have common area space, you end up paying rent for it, in addition to paying CAM charges for its operation, maintenance, and upkeep.

 

6. CPI Rent Escalations

While there are many bases for calculating lease escalations, one of the most popular ones is to tie rent increases to the inflation rate. The Consumer Price Index, or CPI, is the most commonly used measure of inflation for lease escalations. Your lease should specify which variant of the CPI gets used to calculate inflation. Many leases also have caps on CPI increases so, for instance, your lease may say that you will have annual increases tied to the CPI, up to 3%. This means that even if inflation spikes, your rent can't go up more than 3% per year.

 

7. Estoppel Certificate

An estoppel certificate is a document that gets attached to a copy of your lease (and all extensions, additions, amendments and appendices). You will sign it because it certifies that the document you attached represents your actual lease and reflects the entirety of your agreement with your landlord. Estoppel certificates typically come into play when the owner is selling the building -- since the new buyer will want to know exactly what your obligation will be to them -- or when the owner is financing the building -- since the lender wants to know the same.  Most leases require you to sign estoppels on demand, although, as with other lease terms, the specific requirements vary from document to document. Note also that they frequently come at the same time as a request to sign a SNDA (defined below).

 

8. Expense Stop

An expense stop is the maximum amount of operating expenses that a landlord will cover under a gross lease. For instance, if you sign a gross lease and it has a $15.00 per square foot expense stop, this means that as long as the building's operating expenses are $15.00 per square foot or less, you won't have to make any reimbursements. However, if the building's operating expenses go up to $16.25, you would have to pay $1.25 per square foot difference as additional rent.  instead of a dollar amount, some leases use a base year's (defined above) operating expense as an expense stop.

 

9. Full Service / Gross Leases

A full-service lease -- sometimes also referred to as a gross lease -- is one where you make a single payment to the landlord and all of the building's expenses are included. These leases typically include occupancy costs, utilities, taxes, insurance, management, and some, if not all, repairs and maintenance of building facilities within your suite. Typically, a full-service lease will even include janitorial services and the use of building amenities. Usually, the cost of communication services, though, will be your responsibility.

 

As with all leases, the only way to be sure of what your full-service lease does and does not include is to carefully review it. In addition, look for caps on expenses, called expense stops (define above), that might make your gross lease less affordable than you expect.

 

10. Gross Square Footage

A building's gross square footage is its total area, generally calculated by measuring around its perimeter. If a one-story building measures 50 feet by 200 feet, its gross area is 10,000 feet. If the same building has 5 equally-sized stories, it would be 50,000 gross square feet -- 10,000 square feet per floor, times 5.

 

11. Letter of Intent

A letter of intent (LOI) is a document that is a precursor to a contract. Typically a tenant and a landlord or a buyer and seller who are considering entering into a lease or sale will execute a letter of intent to specify the business terms under which they agree to do the transaction. Once both parties agree to the LOI, then they have formal documents -- like a lease or purchase and sale agreement -- drafted. Using an LOI can save time and lower cost since it allows the agreement to be made before bringing in attorneys and complicated legal issues.

 

Many LOIs state clearly that they are not contracts. However, most LOIs also have most (if not all) of the elements of a binding contract. For this reason, it's always a good idea to get legal advice even before entering into an LOI to fully understand your rights and your obligations.

 

12. Load (Core) Factor

A building's load factor is a way of expressing the amount of additional common area space you pay for as a part of your rent. If a building has 350,000 rentable square feet, and 200,000 usable square feet, you would divide 300,000 into 350,000 to get 1.1667. Subtracting the one and converting the remaining 0.1667 to a percentage gives you a 16.67% load factor. This means that you would add an additional 16.67% to the usable square footage measurement of any space in the building to get the rentable square footage. So, a 100-by-60-foot space, measuring 6,000 usable square feet, would be billed out as a 7,000 rentable square foot space, since 7,000 is 16.67% more than 6,000.

 

Load factors typically come into play in buildings with interior corridors.  As such, they are more likely in enclosed office buildings and in large enclosed shopping malls than in open-air strip centers or in industrial buildings.

 

13. Modified Gross Leases

A modified gross lease sits between a full-service lease and a triple net lease. This is a lease where you pay some of the building's expenses and the landlord pays some of them.  The terms of modified gross leases vary from lease to lease, and there is no specific definition that is widely used. Generally, you can assume that with a modified gross lease, you will pay for your own janitorial service and electricity, but beyond that, the only way to be sure is to carefully review the lease's provisions.

 

14. Option to Purchase

Some leases give you an option to purchase. This means that you are given the right to buy the building under certain terms. Depending on how the option is written, the landlord may have to offer the building to you first or may have to allow you to match any incoming office that they are going to otherwise accept. Your option may or may not also have a price or a method for defining it already delineated.

 

15. Options to Renew

Many lease agreements have language that allows you to renew your lease automatically for a pre-set term and at a pre-set rate (either in dollars or as a percentage of fair market value). Options are extremely powerful things since they give you the ability to stay in a building beyond the expiration of your lease without obliging you to do it. This means that you could, for example, sign a five-year lease but have the ability to stay for at least 15 years if you are able to negotiate two five-year renewal options.

 

Options to renew typically have rules on how they can be used. You may need to notify your landlord by a certain date to exercise them. Usually, you will also need to be a tenant in good standing. To use the option, you will also usually need to exercise it with the terms that it contains.  

 

However, having an option doesn't mean that you have to use it.  They do not prevent you from renegotiating with your landlord. They just give you a way to force the landlord to allow you to renew if you want to, even if they would rather do something else with the suite that you occupy. As such, your option usually reflects the least-attractive deal that you can negotiate for yourself.

 

16. Parking Ratio

A building's parking ratio compares the number of spaces in its parking lot to the building's square footage, usually expressed in increments of 1000 sf.  So, if a building has 100,000 square feet and 520 parking spaces, you would divide 520 (spaces) by 100 (thousand square feet) to get 5.2 spaces per 1000 sf, which is a relatively healthy parking ratio.

 

Parking ratios vary by the use of a building -- restaurants and surgery centers need more parking spaces than warehouses.  They also vary based on the location of a building, so a suburban office will need more parking than a downtown high rise where many people use ride sharing or public transportation to get to work. All things being equal though, a building with a higher parking ratio is likely to result in easier parking for your employees or visitors than one with less parking.

 

17. Rent Escalations

Many leases contain clauses, called rent escalations, that allow your landlord to raise your rent over time to keep pace with inflation and with growth in the cost of owning a building. Rent escalations can be expressed as a percentage (for example, your rent goes up by 2 percent per year), as a flat dollar amount (for example, you rent goes up $2 per foot every 3 years), or relative to the CPI (where your rent goes up in accordance with inflation). While rent escalations might not seem like much when you first sign a lease, they can add up and become very significant if you are in a space for a long time.

 

18. Rentable Square Footage

A building's rentable square footage is the total area in the building on which a landlord can charge you rent. To calculate rentable square footage, start with a building's gross square footage, which is the measurement of each floor.  Then, subtract any necessary vertical penetrations like elevator shafts, stairwells, or large penetrations for pipes, cables, or ductwork. Remember to subtract each hole from every floor's area. What is left is the building's rentable square footage -- which is the same thing as the usable square footage plus the common area space in the building. For instance, if a building has ten 15,000 gross square foot floors, and has 250 square feet of vertical penetrations per floor, its rentable area would be 147,500 square feet. To calculate this, take the 15,000 gross square feet per floor less the 250 square feet of penetrations to get a rentable area of 14,750 square feet per floor. Multiply that by the ten stories to get 147,500 rentable square feet in the building.

 

19. Request for Proposal

A request for proposal (RFP) is a document that tenant reps send out to potential landlords to ask them to submit the terms under which they would lease space to the tenant. Usually, RFPs go out after a tenant has toured spaces and identified a shortlist of suitable buildings. After the landlords send back their responses, the tenant and his or her tenant representative can begin the process of negotiating to get to an executed letter of intent, followed by an executed lease.

 

20. Right of First Negotiation

A right of first negotiation is a contract term that requires your landlord to give you the first chance to take over a given (usually, adjacent) suite or to buy the building. This doesn't obligate them to consummate a transaction with you, though. All it does is give you a chance to open a negotiation to do a transaction before anyone else enters a negotiation with them.

 

21. Right of First Refusal

A right of first refusal requires the party granting you the right to take any offer and give you a chance to match it. These rights typically come into play on adjacent spaces -- so you may have a right of first refusal allowing you to stop someone else from leasing the space next to yours (or the floor above or below yours). They also may be offered in your lease if you are a large tenant in a building, letting you buy the building under the same terms as another purchaser. Like options to renew, rights of first refusal are very powerful because they give you the ability not just to lease a space or to purchase the building, but to actively prevent someone else from doing it.

 

22. Subletting (Subleasing)

Subleasing is finding someone to occupy your space and pay you rent for it. You would typically do this if you want to leave your space before the lease expires and if you cannot work out an early termination with your landlord. When you sublease, the tenant that you find pays you rent, and you still pay rent to your landlord. You remain liable for the space and for your entire rent, which means that if you cannot find a tenant pay the full rent, you will still have to pay the difference. To sublease out your space, you need permission from your landlord, and you will also need approval for your specific subtenant.

 

23. Subordination, Non-Disturbance and Attornment Agreement (SNDA)

Frequently attached to estoppel agreements, Subordination, Non-Disturbance and Attornment Agreements (SNDAs) usually come from the lender for a property in which you are a tenant. The agreement does two broad things. First, you agree to subordinate any rights you have to the building to the lender's rights (specifically, their right to foreclose). In exchange for giving the lender that subordination, they give you an agreement of non-disturbance, which means that if they do foreclose, they will not interfere with your tenancy during the term of your lease. Basically, you agree that the lender can foreclose if they want or need to and that it won't affect you, other than changing the address to which you send your rent check. Signing an SNDA upon request is usually a condition of your lease.

 

24. Tenant Improvements

Sometimes also referred to as build-outs, tenant improvements (TIs) are the changes that get made to a space in a building to customize it for your use. If you are leasing space in a brand new building that is being delivered in shell condition, pretty much every interior feature will need to be put into the space so that you can use it. In existing buildings, tenant improvements might be as simple as repainting the walls and replacing a worn-out carpet. Most tenant improvements also stay in the building when and if you leave, since they are part of the construction.

 

25. Tenant Improvement Allowance

As an inducement to get you to sign a lease, many landlords will offer you a tenant improvement allowance. Usually expressed as a dollar amount per square foot, a TI allowance helps you defray the cost of customizing your space. In exchange for providing a TI allowance, the landlord may make additional demands up to and including the use of their recommended construction vendors. Also, remember that if a landlord is giving you "free" money for construction, they're probably making up for it in some other way, such as by charging you higher rent or by offering you less of a rent abatement at the commencement of your lease.

 

26. Triple Net Leases

A triple net lease is one where the landlord's income is net of property taxes, insurance, and common area maintenance. In other words, it's a lease where you pay essentially all of the property's bills for the landlord.  Triple net leases are common when a tenant occupies a building by themselves, although many retail and industrial properties also operate on a triple net basis.  

 

The mechanics of triple net leases vary. If you are in a single-tenant building, you may end up paying for everything -- including property taxes -- directly with the vendor. In a multi-tenant building, you may provide your own en suite janitorial service, repair your own issues in your space, and pay your own utility bills while paying your pro-rata share of the rest of the bills to the property's management. In addition, triple net leases can vary in how they treat large scale building repairs or capital expenditures.

 

While it might seem like triple net leases are heavily weighted towards the landlord's benefit (and, in many ways, they are), they can offer you the ability to save money. Because you pay your own bills, you control your own bills, and you can benefit from efficiencies that reduce your operating expenses instead of having those cost reductions go to your landlord's bottom line like they would in a full-service lease.

 

27. Usable Square Footage

Usable square footage refers to the space inside the demising walls of your suite, or when looked at on a whole-building scale, inside the demising walls of every suite. So, for example, if your space is a box measuring 40 feet by 100 feet, you would have 4,000 usable square feet (40 times 100). In most buildings, you pay rent on your rentable square footage, which is your usable square footage plus your pro-rata share of the building's common area.

 

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