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16 Commercial Real Estate Terms You Need to Know when Renting Office Space

Commercial leases are tricky. Landlords don’t always verbally disclose the terms of an agreement and if you’re a beginner, they may try to take advantage of you. It’s essential to fully understand the terms and conditions of your commercial real estate lease. Otherwise, you risk paying more than you bargained for.

At WindWater, we believe that the real estate process should be transparent. That’s why in this post, we’ll talk about how commercial leases differ from residential contracts. We’ll also help you avoid common pitfalls of first-time lessees by defining 14 critical commercial real estate terms and providing real-life examples of how they work.

How Commercial and Residential Real Estate Leases Are Different

There are two primary differences between commercial and residential real estate leases.

The most significant difference is that the law vigorously protects residential tenants but not commercial tenants.

Residential landlords tend to educate their tenants more about the terms of a lease to avoid legal issues down the road. Commercial landlords aren’t held to the same standard and won’t always be as transparent.

Commercial landlords and the law assume tenants have the training, experience, knowledge and sophistication needed to enter a written contract on their own without guidance. Many first-time office tenants assume that their landlord will explain the terms of a lease, but this isn’t always the case.

There’s also more room for negotiation in a commercial lease than a residential lease. So, when you receive the initial document from your landlord, know that it's not set in stone. You can and should ask to adjust the terms of your lease if you don’t like the presented agreement.

16 Commercial Real Estate Terms 

If you need further explanation or have any questions, please feel free to schedule a call. 

Be sure to also see available offices for rent on our website.

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Commercial Real Estate Glossary 

 

Lease Term

The Lease Term defines the length that lease will be in effect. Your Commencement Date will identify when the lease will start and the Expiration (or Termination) Date will identify when your lease will end. The Lease Term is represented in years and months (ie: 3 yrs and 2 mos) or just in months (36 months or 60 months).  

 

Base Year

The Base Year defines the benchmark year for your operating expenses. Typically this is the year in which your lease begins. In your lease, Landlords will have the right to pass on any operating expenses for the property that exceed the amount of operating expenses that were calculated in your designated "Base Year."

Example: Say the Operating Expenses calculated by the property manager in 2018 were $0.75 per square foot per month. Then, there was an increase in building maintenance, utilities, property taxes, etc., and the 2019 Operating Expenses were calculated at $0.77 per square foot per month. Therefore, the Landlord would add $0.02 per square foot, per month to the Tenant's invoice for the rent in 2019.

 

Operating Expenses

Operating expenses include any costs a landlord incurs through its normal operations of the property. The lease will outline what the Operating Expenses are and who (Landlord or Tenant) is responsible for paying the Expenses. Ultimately, the Tenant pays for the Operation of the property but there can be limits on the landlord's ability to charge for capital costs (ie: HVAC, roof or structural costs). It's important to understand what's included in the Rate Type that the Landlord is offering.

Common operating expenses include:

  • Property taxes
  • Insurance
  • Utilities
  • Trash collection
  • Property management
  • Maintenance and repairs
  • Landscaping
  • Accounting
  • Legal fees
  • Pest control

 

Rate Type - Full-Service Gross (FSG)

In a full-service lease, the owner must pay for all building operating expenses that occur within the base year, and you cover any expense increase after the base year.

Let's say you sign a five-year lease and your monthly rent costs $3,000. Your landlord pays for all operating expenses related to the property and there are no additional expenses to the Tenant during the Base Year.

Some Landlords will not pass-through increases in the property expenses, but most savvy owners will pass-through any Operating Expenses that exceed the amount during the Base Year (see Base Year above).

 

Rate Type - Modified Gross (MG)

A Modified Gross Lease is a hybrid of Full Service Gross (FSG) and Triple Net (NNN)

Typically, the Landlord will pay for a portion of the Operating Expense line items but will either have the Tenant pay or pass-through the remaining Operating Expense line items.

When a Landlord can identify and pass through the exact utilities costs the Tenant is using, the Tenant can potentially save.

 

Rate Type - Triple Net (NNN)

With triple net leases, the tenant is responsible for its pro-rata share of property operating expenses. Some of these could be billed to the Landlord and passed through or billed directly to the Tenant (an electric bill, for example).  

  • Property Taxes
  • Property Insurance
  • Common Area Maintenance & Repairs
  • Utilities
  • Janitorial Service

In a "true" NNN lease, the Tenant is responsible for all operating expenses and the actual management of the property. This is typical for industrial properties and retail properties. Office properties typically operate on a "managed" NNN basis, in which the the Landlord hires a property manager to manage the maintenance and bills for the property and bill those costs to the Tenant.

 

Triple Net vs Full Service

While seemingly different on paper, triple net and full service leases are strikingly similar.  With a triple net lease, the owner passes the building operating expenses onto the tenant. In a full-service lease, the owner pays for the operating expenses during the base year. After the base year, any additional increases in operating expenses are passed onto the tenant.

Take a look at this example of the differences on paper:

A $4,000 a month triple net rate will look more affordable compared to a $4,600 a month full-service lease. However, with a triple net rate you will find there is an additional cost of $800 per month for taxes, maintenance and utilities. The total monthly cost for a triple net lease will come out to $4,800 vs $4,600 for a full-service lease.

While the triple net lease looked more affordable at first, the full-service is actually more cost efficient.

The good news with triple net leases is that if the operating costs decrease year to year, the tenant saves money. With full-service leases, the tenant does not receive a reduction in costs.

Before you sign into a lease agreement make sure you read the fine print and determine what costs are covered.

 

Common
Area Maintenance Fee (CAM)

A common area maintenance fee is any operating expense associated with any space you share with other tenants, customers or property users.

CAM fees can be paid monthly, quarterly, annually or appear on your bill occasionally as maintenance is needed. Make sure you know whether your CAM fees are fixed or variable. If they're variable, check that the contract specifies a CAM fee cap, or the maximum amount that your CAM fees can increase each year.

Never sign a lease without understanding everything your CAM fees cover. Ask the landlord to list all CAM costs in the contract. That way, you won’t be charged for anything that’s not in the agreement.

Verifying what your payments cover will also help you avoid surprise construction costs.

For example, if your owner decides to do a major construction project to improve the business park during your lease term, you must pay a portion of the costs. Projects like this can add up to thousands of dollars per tenant.

If building updates are included in your CAM fees, ask your landlord if there are any scheduled updates before you sign the lease. This gives you the chance to plan for them financially or walk away from the deal.

 

Pass-Through Expense

A Pass-Through is an operating expense that is paid by the landlord and then reimbursed by the Tenant. A good example of this relates to Base Year.  

Example: A Tenant in the third year of their lease may be paying $0.05 PSF in pass-throughs from the increase in Operating Expenses over the Base Year.

 

Rentable Square Feet

Your rentable square footage is the usable square footage of your office space plus a pro-rata share of the common areas of the building. Your pro-rata share is proportional to the amount of space you lease. There are several standards for calculating this amount, but the most typical is Building Owners and Managers Association (BOMA).

An efficient building will have maximum usable square footage in the Tenant's Premises and in today's market, excellent usable common areas that are shared or reserved on an as-needed basis.

 

Usable
Square Feet

Usable square footage is the amount of space the Tenant occupies within the walls of their suite.  

 

Rentable vs. Usable Square Footage

Both rentable and usable square feet impact your rental cost. Here’s an example of the two in use.

Your lease says your space is 10,000 square feet. You want to get your carpet professionally cleaned, but the contractor says your space is actually 8,475 square feet.

Has your landlord been overcharging you?

The answer is probably not — there’s a difference in the space you occupy, versus the amount of space you pay rent on.

To calculate the space between your walls, use the following calculation:

  • Rentable Square Footage/(1 + Load Factor) = Usable Square Footage.

Assuming you rent 10,000 square feet, and the building has a load factor of 18%, you can calculate your usable square footage with the following formula.

  • 10,000 / (1 + .18) = 8,475

Whether the load factor in your building is aligned with other buildings is another question you won’t find the answer to in your lease.

For information on current market load factors, and market trends, call our tenant advisory team.

 

Load Factor

Load factor is a method used to calculate total monthly rent costs. It combines usable square feet and a percentage of common areas in a commercial building to determine rent.

How to Calculate Load Factor

The formula for load factor is:

Property’s Total Square Footage / Property’s Total Usable Square Footage = Load Factor

The total property square footage is the entire area owned, including tenant offices and common areas. The property’s total usable square footage is the amount of space physically occupied by tenants and excludes common areas.

Square footage should be just one way to get a sense of value.  The load factor will help you determine efficiency but it will not put a value on the common areas that are usable square feet. Also, the guidelines for calculating a total property square footage can be skewed based on the architectural elements of the building.

 

Effective Rent

Effective rent is the average rent a tenant pays over the Lease Term.  Some Landlord's prefer to offer free rent to maintain a higher Coupon Rate so it makes sense to compare opportunities by the Effective Rent amount.

 

Total Consideration

The total consideration is the sum of total rent paid throughout the lease. 

For example, if you sign a 24-month lease for $5,000 per month, the total consideration is $120,000.

 

Holdover

If you continue to occupy an office space after the term of your lease is up, you will be considered in Holdover. Holdover will require approval from your Landlord and will be at a premium cost to your current rent. Typically, holdover rent is 150% to 200% of your last month's rent. 

These 15 terms will be a good guide to get you started in identifying opportunities. We will continue to add to this list and are always available to answer more of your questions.

Want to learn more about renting commercial real estate? Read more on our blog.
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Need help finding the perfect space for your business? Contact a WindWater agent today!

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