10 Commercial Real Estate Terms New Investors Need to Know
Someday—hopefully sooner rather than later—the economic recession will abate and the real estate market will come back. When that day comes, investors need to be ready. New commercial real estate investors can get ahead of the game if they understand a few basic but very important terms. Here are 10 key commercial real estate terms that you’ll want to know.
Net Operating Income or NOI
NOI is a relatively simple calculation with big significance. Gross rental income minus expenses—not including mortgage payments or depreciation—equals net operating expenses. NOI determines the value of a property, your cash flow and the offer you’ll make to purchase commercial property.
Return on Investment or ROI
Return on investment is also known as cash on cash return. Divide your annual cash flow by your down payment to calculate your ROI. This percentage tells you how quickly (or not) your money is coming out of a particular property.
Commonly called cap rate, this figure is the result of dividing the net operating income (NOI) by the sale price. Investors often use the cap rate on a property to assess its potential. The higher the percentage of the cap rate, the higher the risk and return. On the other hand, lower cap rates indicate that the overall risk assessment and return on investment are low.
Usable Square Footage
Usable square footage (USF) is the number of square feet a tenant will actually occupy in your building. Non-exclusive and shared spaces such as lobbies, hallways and restrooms are not included in USF.
Rentable Square Footage
The rentable square footage or RSF is the combination of usable square footage and shared spaces in a building. This number is helpful in determining rent for a commercial property.
Common Area Maintenance or CAM
In addition to rent, CAM is a fee tenants pay to a landlord to cover the cost of operating a commercial property. Fees are typically based on rentable square footage and are a portion of the total maintenance charges of the building.
There are three official classifications of buildings:
- Class A buildings are new or almost new, well located, meticulously maintained, feature desirable amenities and command the highest rents
- Class B buildings are older and don’t offer as many amenities, but if they are in a good location they can attract hardworking, budget-minded tenants
- Class C buildings are more than 20 years old and, therefore, may need repairs or improvements
Unofficially, there are class D buildings, which are often vacant and in need of significant repairs and renovation. Know your building classifications, so you don’t end up overpaying for a property or making a deal that does not meet your goals.
A landlord representative is the listing or leasing agent. They represent the best interests of the landlord or property owner and work to secure the highest rent with the least amount of risk and expense.
A tenant rep works on behalf of an individual tenant and has no ties to the lessor or landlord. Tenants turn to these commercial real estate professionals for help finding the right space and negotiating favorable lease terms.
Letter of Intent or LOI
An LOI is a written document that reinforces a tenant’s interest in leasing a space. It is signed before the lease agreement and usually summarizes terms of the lease such as negotiations, concessions and the time frame. Consider yourself lucky to receive more than one LOI, because then you and your broker can choose the tenant you like best.
Needless to say, there are an almost endless number of commercial real estate terms. These 10 are a good start that will help lay the foundation for a solid understanding of real estate investing.