Understanding commercial real estate jargon is extremely helpful in navigating transactions and gaining insight into the industry. Our Cawley Chicago experts pulled together a list of the Top Commercial Real Estate Terms you need to know today. General terms including CAP rates, Vacancy Rates, and Due Diligence as well as modern, essential terms such as Adaptive Reuse, Functionally Obsolete and Force Majeure are detailed in the blog link listed below.
Vacancy rate is the percentage of all available spaces in a lease property that are vacant or unoccupied at a particular time. The vacancy rate is the opposite of the occupancy rate, which is the percentage of spaces in a lease property that are occupied. High vacancy rates indicate that a property is not leasing well while low vacancy rates can point to strong leases.
The absorption rate is the number of properties sold in a month divided by the number of properties on the market. This is an important real estate metric because it goes into determining the price of a property. A space in a market with a higher absorption rate will list for a higher price than the same space in a market with a lower absorption rate. It can also indicate how long a space will be on the market. Rates over 20% indicate a “hotter” real estate market with increasing demand and prices.
Adaptive reuse is the process of taking an existing building and updating or it for a new use or purpose other than which it was originally designed for. Adaptive reuse projects can increase market value and attract investment in an area. This type of construction is also far more environmentally friendly than new construction. Adaptive reuse is different from historical preservation or renovation which is when a building is restored to its original condition rather than retrofitted to a new one.
Real estate is considered functionally obsolete if its design, style, amenities, or technology are outdated, not useful, or not aligned with modern market tastes and standards. For example, if an office building did not offer high-speed internet or strong cellular connection, it would be functionally obsolete. There is “curable” and “incurable” obsolescence. Curable functional obsolescence means that the property could be renovated or upgraded in to bring the property up to modern standards. Incurable functional obsolescence means that the property cannot be upgraded or that it is not economically feasible to do so.
Highest & Best Use
Highest and Best Use is the reasonable, probable, and legal use of vacant land or an improved property. Highest and best use must be physically possible, legally permissible, financially feasible, and maximally productive.
Off market listings are properties that are for sale but are not advertised publicly. The seller may advertise the property privately to potential buyers.
A distressed asset is a property or business that can be bought for less than its value because of major financial issues. The asset may be on the brink of foreclosure or close to default. Investors seek out these devalued businesses and properties to purchase them at a significant discount.
Property Inspection Report
A Property Inspection Report is a detailed, itemized list prepared by a certified inspector that provides an inventory of the property’s major systems and components. The major components of the report are structural, electrical, plumbing and HVAC (Heating, Ventilation and Air Conditioning) system. The findings of the report highlight the property’s strengths and deficiencies.
An environmental study (ESA) is an investigation to identify if there are any potential or existing environmental contamination liabilities. The potential buyers of the property typically assume the cost of the study. An ESA addresses both the land and the physical improvements to the property.
Modified Gross (Net) Lease with Base Year
A modified gross lease base year means that the existing expenses will be paid by the landlord, but any annual increases in the expenses will be assumed by tenants. The base year lease provides landlords security by transferring the risk of increased costs to the tenants. A base year lease is also advantageous to a tenant because it limits the burden for common expenses to increases over the base year level.
The cap rate is a measure used to compare the rates of return on multiple commercial real estate properties. Cap rates are calculated by dividing the property’s net operating income (NOI) from its property asset value. Cap rates are typically used by real estate investors comparing the risk involved in buying multiple commercial properties. Cap rates should not be used to determine the value of single-family homes, properties with irregular income streams, or properties that the investor intends to update or renovate immediately.
Cash on Cash Return
Cash on cash return measures the annual return an investor made on a property in relation to the amount of mortgage paid during the same year. Cash on cash return is calculated by dividing the received net cash flow for the year by the amount of cash invested. A projected cash on cash return between 8 and 12 percent typically indicates a worthwhile investment.
Last Mile Delivery
The last mile refers to the final step of the delivery process where goods are transported from a warehouse or distribution center (aka the last mile facility) to their final destination, which is typically the customer’s doorstep. As consumers increasingly expect speedy deliveries, demand for last mile facility real estate near densely populated urban areas has increased.
Insurance clauses are the limitations of liability policy conditions and general liability risks an insurance provider takes. In other words, an insurance clause in a commercial real estate contract assigns risk. It specifies what insurance coverage is required and who is responsible to pay for it.
In commercial lease agreements, force majeure clauses generally excuse, or temporarily delay, certain landlord or tenant lease obligations due to unforeseen circumstances beyond the parties’ control. These unforeseen circumstances often include acts of God, natural disasters, terrorist activities, governmental restrictions, and an inability to obtain services, labor, or materials. Due to Covid-19, pandemics and epidemics are now often added to this list of unforeseen circumstances.
A Subordination Agreement prioritizes the mortgage loan above the lease. Mortgage lenders want the leases to be subordinate to the mortgage. That way, the mortgage loan is paid first if there is a foreclosure. Most lenders will not agree to loan money unless they get first priority.
The tenant estoppel is a legally binding document that verifies the terms, conditions, and status of a lease. It prevents both the tenant and the landlord from asserting a right that contradicts what they previously agreed to.
Common Area Maintenance (CAM) expenses are fees that tenants pay landlords to cover the cost of operating the common areas of a property. This can include cleaning, security, maintenance, property taxes, and property insurance.
A 1031 Exchange allows investors to avoid paying capital gains taxes when they sell one investment property and reinvest the proceeds into another investment property. The purchase must take place within certain time limits and be of like kind and equal or greater value. A 1031 Exchange is named after Section 1031 of the U.S. Internal Revenue Code
Due Diligence Timeframe
The due diligence timeframe is when the buyer is permitted to enter the property to study, examine and inspect it before they decide to move forward with the transaction. The due diligence timeframe is also known as the investigative period, feasibility period, and study period.
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SOURCES: Investopedia and Rocket Mortgage