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Do your research: 16 Commercial real estate terms you should know before signing on the dotted line [2020 edition]

Securing NYC office space can be challenging, especially if you’re in a time crunch and not sure how to navigate the commercial real estate market. We get it…it’s an intimidating industry—and the fact is that residential real estate experience doesn’t prepare you for dealing with commercial real estate. That’s why we believe  the smartest buyer is also an educated buyer.

And while chances are you’ve heard commercial real estate terms like “tenant improvement” and “Class-A space” floating around, it’s easy to nod along passively, rather than admit you’re lost and don’t understand a term that’s being used.

At PivotDesk, we help individual businesses at every stage find a solution for their office space needs. Here’s a list of real estate terms we encourage our clients to know before signing a commercial real estate lease or commercial sublease. Understanding these key terms will make you feel much more informed and ensure you know your rights as you conduct your search.

The People Behind the Deal

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#1: Tenant Representative: A tenant “rep” is a commercial real estate realtor that represents the interests and rights of the individual tenant instead of the landlord. Although not a legal representative per se, it’s a bit like a tenant having their own lawyer to use for lease negotiations. The tenant rep can offer advice and help identify office space needs, negotiate with the landlord or landlord representative on lease terms, try to ensure you pay the most reasonable amount of money possible, keep you from agreeing to unfavorable contract terms, and in general help free up your time so that you don’t have to take on the entire responsibility of the process by yourself. Tenant reps earn their fee by splitting the commission with the leasing agent. They can also help resolve tenant-landlord disputes and serve as an intermediary for tenants. If you are new to the commercial real estate market, you’ll need someone on your side that can protect your interests and steer you towards the right NYC office space.

#2: Landlord Representative: A landlord “rep” is the leasing agent. They represent the best interests of the owner or landlord and are responsible for obtaining the highest price of rent with the least amount of expense and risk. A landlord representative is authorized to negotiate terms with the tenant or tenant representative on behalf of the landlord, to secure a rental agreement that details rental costs, security deposits, tenant improvement allowances, and additional concessions. They often have a lot of experience and will negotiate the best possible deal for the owner or landlord. If you don’t have a tenant representative and are not familiar with the typical real estate clauses, provisions, and legal issues that could affect you down the road, you may be at a serious disadvantage.

#3: Co-broker: Oftentimes the landlord will sign an exclusive listing agreement with a commercial real estate broker on a newly available property. In order to expand reach and get the property rented faster, the broker will invite other brokers to view and rent the property, and split the commission with them should their client end up leasing the property. When looking at a commercial lease or sublease, make sure you know who you are dealing with. Is it the listing agent/broker or someone else? If it’s a co-broker, know that they can’t sweeten the deal unless they talk to the listing broker since they don’t have the direct connection with the landlord. As a result, negotiations could be stunted and subject to a bit of telephone. While brokers are motivated to get the deal done, they have very little incentive to affect their commission negatively, so always know where you stand.

#4: Referral Fee: One of the more straightforward commercial real estate terms, a referral fee in commercial real estate is the fee paid from one broker or agent to another when they refer a client. Typically, the price is a percentage of the commission. This is different from a co-broker. A co-broker is actively trying to rent the property in order to secure the commission. Referral fees are paid when a broker simply points a client to another broker. This usually happens when a broker is referring a client to an area that they are not working in or familiar with. As a client, this isn’t something you will need to worry about.

What You’re Really Paying For

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#5: Building Classifications: This is one of those commercial real estate terms that refers to multiple terms because there are actually three classes of office buildings – A, B and C. Class A buildings are high-end office spaces that are new, well maintained high rises with quality amenities in prime locations. Landlords command premium rents in these office spaces, so they are coveted, but not necessarily an option if you are on a tight budget. Class B buildings are average in nature with lesser amenities and tend to be no more than four stories tall. They may have once been Class A, but wear and tear downgraded their classification and lessened their market value. Class C buildings are usually more than 20 years old and in need of major repairs. Locations are less desirable and rents are at a much lower price, but with renovation, they can be upgraded to Class B. It’s important to understand the classification of the building you are leasing to ensure that you aren’t overpaying for rent.

#6: Usable Square Footage: Among the most important commercial real estate terms for you to know, usable square footage (USF) is the actual space you can occupy in a commercial rental property. Non-exclusive spaces and common areas such as lobbies, restrooms, stairways, hallways, and storage rooms are not included in USF. However, if you leased an entire floor, restrooms and hallways would be counted as usable square footage since it’s exclusive to your company. To calculate USF, subtract the shared square footage from the total floor area.

#7: Rentable Square Footage: Rentable square footage (RSF) is a term referring to the total usable square footage plus the shared spaces of the building. This includes the shared lobbies, hallways, restrooms and storage areas, which you pay for. To calculate RSF, you need to determine the “common area factor.” To do so, divide the total floor area by the usable square footage. On average, the common area factor ranges from 10-20%.

#8: Common Area Maintenance (CAM): Common area maintenance is a fee paid to the landlord in addition to rent to maintain your office space. This term is two-fold, as there are two different types of CAM fees – variable and flat. Fees are based on total rentable square footage and represents a pro-rata fee of the total maintenance charges for the building. These fees can include anything from insurance, repairs, landscaping, cleaning services, utilities, snow removal security costs, and more. At times it can include administrative and management fees and salaries. CAM fees are calculated based on a percentage of the total costs so you will want to negotiate a cap on these fees and ensure that these fees are narrowly defined to control your costs.

#9: Concessions: Commercial lease concessions are negotiated allowances that include a discounted price or free rent for a fixed period of time, reduced escalations, tenant improvement allowances, or other favorable terms on offer. Anything offered upfront probably means that the landlord has already covered it in the rent, but beware. Sometimes a clause in the lease allows the landlord to revoke the concessions if you default on your lease, and make you liable to pay those costs. You can also renegotiate concessions at the time of renewal, but this is best done with the help of a broker and a lawyer.

#10: Tenant Improvements: Tenant improvements in commercial real estate are new changes or alterations tenants can make to the property to customize the space to suit their needs. This can include flooring, ceilings, office partitions, air conditioning, painting, security costs, and more. Tenant improvements should be negotiated before you sign the lease to outline how much money the landlord will commit towards these improvements. This is called a tenant improvement allowance (TIA). Once negotiated, any amount over the TIA will be the responsibility of the tenant. Therefore, it’s best to know how much the improvements will cost before you sign on the dotted line of a legal contract.

Before Signing a Commercial Lease

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#11: Letter of intent: A term often abbreviated as a LOI, a letter of intent to lease a commercial office space is a written document that solidifies the tenant’s interest in and commitment to rent the space. This comes before signing the lease agreement and typically summarizes the terms of the lease including the negotiations, concessions, and time frames agreed to. The letter of intent could be binding or non-binding so be sure to know what you are agreeing to before signing it. Non-binding letters of intent can be prepared by a broker, but should contain language that makes it clear that the letter does not formally tie you to the property, such as “the parties are not bound by this agreement.” If it doesn’t contain very clear language like this, get a legal representative.

#12: Net Operating Income (NOI): One of the most crucial terms used in commercial real estate sales, especially among real estate buyers concerned about their return on investment, NOI refers to a figure that is calculated when you take the total amount of a landlord’s gross rental income on a commercial property minus their expenses. Relevant expenses in this case are property expenses only, not mortgage payments or depreciation. Knowing the NOI is key to determining the return on real estate investment properties.

#13: Capitalization Rate (Cap rate): The cap rate is also among the most important terms in commercial real estate sales, particularly to those who buy investment properties. You get the cap rate when you divide the net operating income (NOI) by the sale price. The capitalization rate provides a useful measure for a property’s performance so the buyer knows what kind of return to expect. As with NOI, the cap rate is a more relevant term to the property owner than to the tenant.

#14: Triple Net Lease: This is one of the most critical commercial real estate terms for you to know if you are searching for a property because it can have a big effect on how much you are responsible for when renting office space. A triple net lease, otherwise known as NNN, is a lease contract where the tenant pays rent plus all operating expenses such as repairs, service and maintenance; real estate taxes; and insurance (contrast this with a gross lease, where the tenant only pays the rent). The triple net lease is obviously a good arrangement for the landlord, but for tenants it has its pros and cons. While rents are typically cheaper with a NNN lease, the costs can be variable, especially for older buildings where capital expenditures are generally high. If you enter into a triple net lease, stick with a relatively new building and get a sense of what the maintenance fees are and how well it’s been maintained in the past.

#15: Sublease clause: If you are leasing an entire floor, you should understand whether or not subleasing is allowed. Subleasing is a way to offset some of your costs by assigning part of your lease to another tenant. You can remain in the property with the other tenant or sublease the entire office space to another tenant. The terms in your original lease with the individual landlord must stipulate whether or not you can also sublease and if the landlord must consent to the tenant. Landlord consent is typically based on credit history, finances, and the sublessee’s willingness to abide by the original terms of the lease. Legally, this landlord consent cannot be unreasonably delayed or withheld. Also look for clauses within the clauses that put additional restrictions on your ability to sublease. If your lease fails to mention subleasing, you may be free to do so without the consent of the landlord, but as always – check with a lawyer.

#16: Escalation clause: An escalation clause increases the price of the rent on an annual basis. Increases could be based on a percentage of the Consumer Price Index (CPI) or increases in property taxes, operating expenses, or all of the above. Escalation clauses are used in long term commercial leases to help landlords cover the increasing cost of property ownership year over year. To avoid escalating rent prices that could push you out of your office space, try to negotiate a cap and delay the time period that the escalation clause kicks in for at least two years. Better yet, negotiate a fixed increase each year that is NOT based on the CPI to help control your own costs.

We hope this glossary of terms has been helpful in teaching you some of the most relevant commercial real estate terms that you should know as you embark on your hunt for a new office space. We also hope you will now feel much more confident as you charge ahead in your mission to find the perfect piece of commercial real estate.

Gather Your Team

Commercial real estate leasing can be complex, but if you are ready for your own new space and want to make a long term commitment, it’s important to educate yourself on the process and ensure you have the right team in place. From there, you can employ a tenant representative and a good real estate attorney that will protect your interests and secure the best deal possible. They can save you thousands of dollars, valuable time, and help you find the right office space for the long run.

Not sure where to find a broker you can trust? PivotDesk can help with that.

We work with top commercial real estate firms across the country to help our customers find the right office space solution, and would be happy to make an introduction. We highly recommend SquareFoot for its technology-forward approach to helping clients find prime office space. A number of former and current PivotDesk customers have found success with the firm.

Not so sure your business is ready for the commitment (financial and legal!) required to sign a commercial lease? Check out PivotDesk’s inventory. You can secure excess office space on a month-to-month basis without signing a lease in a premium location and avoid the escalating expenses that come with a full fledged commercial office space rental. And when you are ready, you can PivotDesk your excess office space and find like-minded companies to share your space.

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