10 Must-Know Commercial Real Estate Terms
We know leasing your first commercial space can be an intimidating process, especially when you don’t feel like you fully understand the terminology that is being used. That’s why we’ve put together this handy guide of our Top 10 Must-Know Commercial Real Estate Terms to help you navigate your negotiations like a seasoned pro:
1) Letter Of Intent (LOI)
A Letter of Intent (often referred to as a LOI) is typically the first step taken when two parties choose to start the process of negotiating a deal. Because commercial real estate documents like leases and purchase agreements are frequently complex, most brokers will choose to submit an initial LOI to the seller or landlord on behalf of their clients to help both parties quickly get up to speed with what each side is looking for in the deal. A short document, the LOI will clearly spell out the most important deal points so each party can easily decide if they are interested in further negotiations. Eventually, the LOI may also get used to draft the official legal documents if the deal moves forward.
2) Rentable vs. Usable Square Feet
When you rent a commercial space, the area inside its walls is called the “Usable Square Footage.” So, for example, if you had an office in a high-rise building, the “usable square footage” would encompass the total square footage of your personal office space on the 12th floor. However, usually you’ll also have to pay for your share of the building’s common areas, such as the lobby, hallways, elevators and bathrooms (things that even though they aren’t in your office space, you still use on a daily basis). The combination of the two is called your “Rentable Square Footage.” So even though your office space may only be 5,000 SF (Usable SF), you may end up paying rent on 5,600 SF(Rentable SF) of space.
3) Load Factors
Load Factors are simply a quantitative way to express just how much of a building’s common area space, you as a tenant, are personally responsible for paying for. Say, for example, you rent that 5,000 SF of usable space we mentioned above, and then you also have to pay for 600 SF of the building’s common area space. In this scenario, your space would have a 12 percent load factor since 5,600 divided by 5,000 is 1.12 or 12 percent more. These percentages let tenants easily compare the load factor for different buildings in which they may be interested, since a higher load factor will mean that more of a tenant’s monthly rent will be dedicated to common area space and less to the suite they occupy. However, that being said, buildings with higher load factors will also often have more amenities, such as spacious lobbies, atriums or shared conference rooms which can be extremely valuable assets to your business.
4) Rent Escalations
Most commercial leases you encounter will have language in them that states that the rate you agreed to paid initially will go up periodically over time. This is typically done to ensure that the base rent will keep up with inflation. These increases are referred to as “Rent Escalations” and are very common in commercial real estate.
5) Tenant Improvements (TI)
Most of the time when you lease new space, you’ll need to have it customized to fit your needs. These customizations are referred to as “Tenant Improvements” (or “TI” for short). Often times, landlords will offer to pay some or all of these costs for you, depending on the condition of the space they are leasing out and how much work they know it will need to be ready for occupancy.
6) Common Area Maintenance (CAM)
As discussed above, most buildings have some amount of common area space, things like lobbies and elevators, or even external landscaping for the building. Well, those things need to be kept clean and maintained. Imagine having your clients walk up to a building overgrown in weeds and into a lobby with overflowing trashcans and a dirty floor. So, in order to maintain these areas, some leases have what they refer to as Common Area Maintenance (or CAM for short) charges. This is simply the share of your building’s operating/maintenance expenses that you’ll pay each month. It’s worthwhile to keep in mind that this isn’t typically a profit center for your landlord, they are simply trying to recover the costs of upkeep on the building.
7) Options To Renew
One of the most favorable terms that you can have your commercial real estate broker negotiate for you on your behalf is an “Option To Renew”. Simply put, options to renew grant the tenant an option, or several consecutive options to renew their lease after their initial term is up, typically including set rental rates for those renewals.
8) Full Service, Modified Gross & Triple Net Leases
We’ve outlined these different lease types before in great detail HERE on our blog. But here’s a quick explanation of each:
Full Service: The asking rental rate for the property includes all operating expenses for the property, which can include janitorial services, CAM, utilities, property taxes and property insurance.
Triple Net Lease (Typically listed as “NNN”): The rental rate includes the base rent only, then the tenant will also be responsible for paying a portion of all three nets on the property (Net Taxes, Net Insurance, Net Common Area Maintenance). In addition, the tenant will also be responsible for covering their utilities and janitorial services.
Modified Gross: The rental rate will include the base rent and will also typically include any or all of the “nets.” Utilities and janitorial services are typically excluded from the rent and must be covered by the tenant.
9) Rent Commencement Date vs. Lease Commencement Date
The “Lease Commencement Date” is the date in which the lease goes into effect and legally binds both parties to the terms of the lease. The “Rent Commencement Date” however, is the date on which the Lessee will begin to pay rent to the Lessor. In many cases these dates are the same, however these dates can also often be different. For instance, this can occur when work needs to be done to a space prior to a new tenant moving in. As an incentive, Landlords may offer a rent-free period of several months as the tenant builds out their space and prepares it for occupancy. Rent Commencement Dates may also either be fixed or floating dates tied to an action or event instead of a date on a calendar. For example, you may negotiate for your Rent Commencement Date to be upon receiving your certificate of occupancy. This ensures that even if there are delays in the build out process, you won’t begin paying rent until the agreed upon event occurs.
10) Condition Of Premises & Delivery Specifications
Cold Dark Shell, Warm Grey Shell, Warm Vanilla Shell, these may sound like delicious flavors of ice cream, but actually they are descriptions for how your landlord is agreeing to deliver your newly rented space to you. Often a confusing mess of words and terms that vary drastically from brokerage to brokerage, we wrote a whole blog sorting through and explaining what all of these terms mean HERE. But here’s the quick version:
In your lease, your landlord is going to outline the “Condition Of The Premises” or the “Delivery Specifications” to you, basically what condition your space will be in when you move into it. Will it have power? Floors? Drywall? HVAC units? HVAC distribution? Lighting? Restrooms? Or will the space be what is called “Turn Key Space,” fully built out and ready to move in and plug and play? These are all important specifications that will be outlined under the condition of the premises and delivery specifications in your lease.