Commercial Real Estate Lingo – 10 Terms You Need to Know
Every career field has its own lingo and sometimes we come into a field that has a lot of jargon. Commercial real estate is one of those fields and if you don’t have a background in it, the feeling of understanding what’s going on can become overwhelming. After being at my job for over 6 months, I thought it was a good time to share the 10 most common words in commercial real estate that everyone should know.
- Building Classifications – Building classifications in most markets refer to Class “A”, “B”, “C” and sometimes “D” properties. While the rating assigned to a particular building is very subjective, Class “A” properties are typically newer buildings with superior construction and finish in excellent locations with easy access, attractive to credit tenants, and which offer a multitude of amenities such as on-site management or covered parking. These buildings, of course, command the highest rental rates in their sub-market. As the “Class” of the building decreases (i.e. Class “B”, “C” or “D”) one component or another such as age, location or construction of the building becomes less desirable. Note that a Class “A” building in one sub-market might rank lower if it were located in a distinctly different sub-market just a few miles away containing a higher end product.
- Cap Rate – Short for capitalization rate. Unleveraged initial yield on the investment expressed as the annual Net Operating Income divided by the property price (or asking sales price)
- Common Area Maintenance (CAM) – This is the amount of additional rent charged to the tenant, in addition to the base rent, to maintain the common areas of the property shared by the tenants and from which all tenants benefit. Examples include: snow removal, outdoor lighting, parking lot sweeping, insurance, property taxes, etc. Most often, this does not include any capital improvements that are made to the property.
- Concessions – In negotiations to attract tenants, a landlord will sometimes grant concessions. These most often take the form of free rent but may also include lease buyouts, moving allowances and above-standard tenant improvement allowances. In a hot real estate market concessions are difficult to negotiate.
- Net Absorption – The net change in occupied space in a given market between the current measurement period and the last measurement period. Net absorption can be either positive or negative and must include decreases as well as increases in inventory levels. It is recommended to disclose the inclusion (Total Net Absorption) or exclusion (Direct Net Absorption) of sublease space in any calculation of net absorption.
- Net Operating Income – (NOI) A calculation used to analyze real estate investments that generate income. Net operating income equals all revenue from the property minus all reasonably necessary operating expenses. Aside from rent, a property might also generate revenue from parking and service fees, like vending and laundry machines. Operating expenses are those required to run and maintain the building and its grounds, such as insurance, property management fees, utilities, property taxes, repairs and janitorial fees. NOI is a before-tax figure; it also excludes principal and interest payments on loans, capital expenditures, depreciation and amortization.
- REIT – (Real Estate Investment Trust) – A security that sells like a stock on the major exchanges and invests in real estate directly, either through properties or mortgages. REITs receive special tax considerations and typically offer investors high yields, as well as a highly liquid method of investing in real estate.
- Return on Investment – (ROI) A performance measure used to evaluate the efficiency of an investment or to compare the efficiency of a number of different investments. To calculate ROI, the benefit (return) of an investment is divided by the cost of the investment; the result is expressed as a percentage or a ratio. ROI = (Gain from Investment – Cost of Investment) / Cost if Investment
- Tenant Improvements or Tenant Improvement Allowance – (TI) the customized alterations a building owner makes to rental space as part of a lease agreement, in order to configure the space for the needs of that particular tenant. These include changes to walls, floors, ceilings, and lighting, among others. In actual practice, these customized tenant improvements usually have a useful economic life of 5 to 10 years, which spans the average commercial lease term.
- Triple Net Lease – (NNN) A lease agreement that designates the lessee (the tenant) as being solely responsible for all of the costs relating to the asset being leased in addition to the rent fee applied under the lease. The structure of this type of lease requires the lessee to pay for net real estate taxes on the leased asset, net building insurance and net common area maintenance. The lessee has to pay the net amount of three types of costs, which how this term got its name.