Important Commercial Real Estate Terms You Should Know
Commercial real estate is far more complex than residential real estate. The contracts are longer, often the price tags are higher, and included in the process are many complex terms that an ordinary person does not understand. Make sure before entering into a commercial real estate deal you are aware of these terms.
- Capitalization Rate (CAP Rate)
A Capitalization Rate, also known as a “CAP Rate,” is a term that is used to help determine the potential real estate deal. This term is based off of an algorithm by dividing the net operating income (NOI) by the sales price of the property (the fair market value of the property). Therefore, this result gives you the return rate on your real estate interment. Many real estate investors acquire what the CAP rate is on property before purchasing a commercial real estate lot.
- Usable Square Footage
The USF, or usable square footage, is the amount of space that is actually available to be used in a commercial real estate rental property. There is a tremendous amount of space that is not useable such as exit hallways, stairways, bathrooms, etc. Therefore, the USF gives you an accurate idea of how much working space you have.
- Rentable Square Footage
The RSF, or rentable square footage, is the total amount of space, including any shared space. This footage will give you an accurate expectation of the amount of working space and shared space such as lobbies, bathrooms, hallways, etc. Landlords primarily use this number to determine the rental amount for the commercial property.
- Common Area Maintenance
CAM, or the Common Area Maintenances, is the amount of expenses you are responsible to pay for maintaining the building. Each landlord may calculate this differently; however, you should inquire with the landlord how the CAM has been calculated.
- Right of First Refusal
The Right of First Refusal, or ROFR, gives the tenant the ability to accept or decline any additional space that the landlord has available to rent. Therefore, the landlord would be required to offer to the tenant with a ROFR clause included in their lease any additional space before offering that space to the general public.
- Sublease Clause
A sublease clause may or may not be included in the contract. This clause either permits or prohibits a tenant from subleasing their space to another individual or business. A sublease occurs when the tenant rents to someone else only a partial amount of time during the remaining time of the lease. Make sure you know if you are permitted to sublease in case an emergency arises.
- Assignment Clause
An assignment clause may prevent or prohibit the tenant from transferring the entire interest away to another person. Unlike sublease clauses which permit a tenant to reassume the space, after subleasing to someone else, the assignment clause transfers all the interest and does not allow the transferor to reassume his or her interest. In an assignment situation, the person who receives the assignment will be responsible for rent until the end of the lease term.
- Escalation clause
An escalation clause will explain the amount the rent will escalate or increase annually. The increase may be determined based upon the property taxes, operating expenses, or even the Consumer Price Index.