Your Essential Guide to Commercial Real Estate Terminology
By Khai Tran | khaitranofficial.com
Commercial real estate represents a massive opportunity for residential agents. But the terminology can feel like a foreign language. This guide breaks down the 10 most important terms you'll encounter, giving you the confidence to handle CRE conversations and recognize opportunities.
How to Use This Guide: Read through each term, review the examples, and reference the quick chart at the end. Keep this handy for client meetings and deal reviews.
Definition: Fees charged to tenants to cover the costs of maintaining shared spaces in a commercial property, such as parking lots, lobbies, hallways, landscaping, and common utilities.
Real-World Example:
A tenant leases 2,000 sq ft in a 10,000 sq ft office building. The annual CAM charges are $20,000 total. The tenant pays 20% (their proportion of the building) = $4,000/year or $333/month on top of base rent.
When to Use It: When discussing lease agreements or explaining additional costs beyond base rent to commercial clients.
Common Mistake to Avoid:
Forgetting to include CAM charges when calculating a tenant's total monthly expense. Always ask: "Is this rent plus CAM, or is CAM included?"
Definition: A lease structure where the tenant pays all three "nets": property taxes, insurance, and maintenance (including CAM). The landlord receives "net" rent with minimal expenses.
Real-World Example:
A retail tenant signs a NNN lease at $25/sq ft for 5,000 sq ft ($125,000 base rent/year). They also pay their share of property taxes ($15,000), insurance ($5,000), and maintenance ($10,000). Total: $155,000/year.
When to Use It: Common in retail and single-tenant commercial properties. Critical for landlords seeking predictable income.
Common Mistake to Avoid:
Confusing NNN with gross leases. In NNN, tenants pay nearly everything. In gross leases, the landlord covers most expenses.
Definition: The rate of return on a real estate investment based on the income the property generates. Formula: Cap Rate = Net Operating Income (NOI) / Property Value
Real-World Example:
A property generates $100,000 in NOI per year. It's valued at $1,250,000. Cap Rate = $100,000 / $1,250,000 = 8%. This means the property returns 8% annually before financing.
When to Use It: Evaluating investment properties, comparing deals, or determining property value based on income.
Common Mistake to Avoid:
Using gross income instead of NOI. Cap rate must be calculated with NOI (income after expenses but before debt service).
Definition: The annual income a property generates after operating expenses but before debt service (mortgage payments) and taxes. Formula: NOI = Gross Income - Operating Expenses
Real-World Example:
A building generates $500,000 in rental income (gross). Operating expenses (management, maintenance, insurance, property taxes, utilities) total $200,000. NOI = $500,000 - $200,000 = $300,000.
When to Use It: Underwriting deals, calculating cap rates, determining cash flow before financing.
Common Mistake to Avoid:
Including mortgage payments in NOI. Debt service is NOT part of operating expenses.
Definition: A non-binding document that outlines the basic terms of a proposed lease or purchase before a formal contract is drafted. Sets the framework for negotiations.
Real-World Example:
A buyer submits an LOI offering $2M for a property, with 30 days of due diligence, a $50K earnest deposit, and closing in 60 days. The seller reviews and counters at $2.1M. They negotiate until both agree on terms, then draft a PSA.
When to Use It: Early stages of a transaction to establish mutual interest and key deal points before spending money on legal contracts.
Common Mistake to Avoid:
Treating an LOI as a binding contract. While some provisions (like exclusivity) may be binding, most terms are not enforceable until the PSA is signed.
Definition: A lease structure where the landlord pays most or all operating expenses (taxes, insurance, maintenance), and the tenant pays a single "gross" rent amount.
Real-World Example:
An office tenant signs a gross lease at $30/sq ft for 3,000 sq ft. They pay $90,000/year ($7,500/month) all-in. The landlord handles property taxes, insurance, and common area maintenance from that rent.
When to Use It: Common in office buildings and multi-tenant properties where the landlord wants simplicity and control over expenses.
Common Mistake to Avoid:
Assuming "gross" means the tenant has zero additional costs. Some gross leases have expense stops or escalation clauses for increases beyond a base year.
Definition: Customizations made to a commercial space to suit a tenant's specific needs (e.g., walls, flooring, fixtures). Often negotiated as a TI allowance (dollar amount per sq ft) provided by the landlord.
Real-World Example:
A medical office tenant needs exam rooms and specialized lighting. The landlord offers a $40/sq ft TI allowance on a 2,500 sq ft space = $100,000. The tenant's buildout costs $120,000, so they cover the $20,000 overage.
When to Use It: Lease negotiations, especially for new tenants moving into raw or shell space.
Common Mistake to Avoid:
Not clarifying who manages the construction and what happens to unused TI funds. Get it in writing.
Definition: The legally binding contract between buyer and seller outlining the terms of a property sale, including price, contingencies, due diligence periods, and closing date.
Real-World Example:
After negotiating via LOI, the buyer and seller sign a PSA for a $3M office building. The PSA includes a 45-day inspection period, $100K earnest money (non-refundable after due diligence), and a 90-day close.
When to Use It: After the LOI stage, when both parties are committed and ready to formalize the transaction with legal enforceability.
Common Mistake to Avoid:
Skipping attorney review. CRE PSAs are complex and should always be vetted by real estate counsel.
Definition: The rate at which available commercial space in a specific market is leased or sold over a given period. Indicates market strength and demand.
Real-World Example:
A submarket has 500,000 sq ft of available office space. Over 6 months, 100,000 sq ft is leased. Absorption rate = 100,000 sq ft / 6 months = 16,667 sq ft/month. At this rate, it would take 30 months to absorb all available space.
When to Use It: Market analysis, advising investors on timing, understanding supply vs demand dynamics.
Common Mistake to Avoid:
Ignoring new construction in the pipeline. Absorption rate considers current inventory, but new supply can change the market quickly.
Definition: A tax-deferred strategy (IRS Section 1031) allowing investors to sell a property and reinvest the proceeds into a "like-kind" property, deferring capital gains taxes.
Real-World Example:
An investor sells a retail property for $1.5M with a $500K gain. Instead of paying capital gains tax (~$100K+), they use a 1031 exchange to purchase a $1.8M apartment building within 180 days, deferring all taxes.
When to Use It: Advising clients on tax strategies, helping investors scale portfolios, or structuring exit plans.
Common Mistake to Avoid:
Missing the strict timelines: 45 days to identify replacement property, 180 days to close. Also, primary residences don't qualify (must be investment property).
| Term | What It Means (Quick Version) |
|---|---|
| CAM | Shared expense fees for common areas |
| NNN Lease | Tenant pays taxes, insurance, maintenance |
| Cap Rate | Annual return % based on NOI / Value |
| NOI | Income after expenses, before debt |
| LOI | Non-binding proposal to start negotiations |
| Gross Lease | Landlord covers most expenses, tenant pays flat rent |
| TI | Buildout costs for tenant's custom needs |
| PSA | Legally binding purchase contract |
| Absorption Rate | Speed at which market space is leased/sold |
| 1031 Exchange | Tax-deferral strategy for investment properties |
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