Commercial real estate deals are often far more complex than those found in residential real estate. Because commercial real estate properties are almost always income-producing, there are a number of business concepts that are both common to business in general and unique to the commercial real estate field. Here are a number of important commercial real estate terms that everyone getting into this exciting and dynamic industry should know.
Capitalization rate (or CAP rate)
The capitalization rate on any commercial property is arguably the single most important metric for the building’s owner. It is essentially the same thing as the property’s rate of return. However, the term rate of return is not typically used in commercial real estate because there are multiple ways of measuring returns on capital, especially where debt comes into play.
The CAP rate is simply the monthly net rental income divided by the purchase price of the property. This measure gives potential property buyers a good indication of the long-term profitability of the real estate.
Usable square footage (USF)
With residential properties, all parts of the home can be counted towards the total square footage because those areas are private and are frequently used by the owners. However, with commercial properties that are designed to house for-profit businesses, areas like hallways, stairways, bathrooms and other common areas cannot be used for the business’ specific activities. Therefore, only the areas that can be directly used by the tenants for their business activities can be counted as usable square footage.
Rentable square footage
This is the amount that includes all common areas, including hallways, lobbies and bathrooms. The rentable square footage is usually the figure that owners use to set the total rent amounts.
Common Area Maintenance
Just as condominiums have association fees that cover all of the maintenance costs for the common areas, commercial properties have monthly or yearly fees that all tenants are required to pay. This money goes towards keeping both the interior and exterior common areas in presentable condition, including keeping any parking areas or external drives plowed in winter and nicely landscaped in summer.
Right of first refusal
Unlike with residential properties, commercial properties often give current tenants the right to rent any space that becomes freed up within the property. This is done as a courtesy to businesses that may need the additional space or not want other businesses present on the property.