Do your research: 14 Commercial real estate terms you should know before signing on the dotted line [2019 edition]

Do your research: 14 Commercial real estate terms you should know before signing on the dotted line [2019 edition]

By: Nell Gable in Leasing

The People Behind the Deal

#1: Tenant Representative: A tenant “rep” is a commercial real estate realtor that represents the tenant instead of the landlord. They help identify office space needs and negotiate with the landlord or landlord representative. 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 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 amount of rent with the least amount of expense and risk. A landlord representative is authorized to negotiate 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 other 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 and provisions that could affect you down the road, you may be at a serious disadvantage.

#3: Co-broker: Oftentimes landlord will sign sign an exclusive listing agreement with a commercial real estate broker. 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: A referral fee in commercial real estate is the fee paid from one broker or agent to another when they refer a client. Typically, this 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

#5: Building Classifications: There are 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. 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 twenty years old and in need of major repairs. Locations are less desirable and rents are much lower, 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: Usable square footage (USF) is the actual space you can occupy in a commercial rental property. Non-exclusive spaces 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 uUSF, subtract the shared square footage from the total floor area.

#7: Rentable Square Footage: Rentable square footage (RSF) is 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. There are two 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. Sometimes 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 discounted or free rent for a fixed period of time, reduced escalations, or tenant improvement allowances. 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 for 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 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 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.  

Before Signing a Commercial Lease

#11: Letter of intent: Often referred to as a LOI, a letter of intent to lease a commercial office space is a written document that solidifies the tenant’s 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 timeframes 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 lawyer.

#12: Triple Net Lease: A triple net lease, otherwise known as NNN, is a lease where the tenant pays all operating expenses such as repairs and maintenance. This is 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 newer building and get a sense of what the maintenance fees are and how well it’s been maintained in the past.

#13: 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. Your original lease with the landlord must stipulate whether or not you can 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.

#14: Escalation clause: An escalation clause increases 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.

Commercial real estate leasing can be complex, but if you are ready for your own 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 and help you find the right office space for the long run.

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