Entering the world of commercial real estate can be overwhelming, especially if you aren’t familiar with the terminology. It is just as complex as it is intriguing. We have gathered ten of the most important commercial real estate terms to help you grasp the basics of real estate. We believe that these commercial real estate terms are essential to understanding the process of a commercial real estate transaction:
- Building Classifications (A, B, C)
- Capitalization Rate (CAP Rate)
- Debt Coverage Ratio
- Letter of Intent (LOI)
- Net Operating Income (NOI)
- Purchase & Sale Agreement (PSA)
- Tenants in Common (TIC)
- Return on Investment (ROI)
- Triple Net Lease (NNN)
10 Commercial Real Estate Terms You Should Know
A broker is essentially a real estate agent who has the ability to manage their own business. They can work independently or hire other agents to work for them. Becoming a broker requires additional training and you must pass a broker exam after working as an agent for typically 1-3 years.
Building Classifications (A, B, C)
Class A buildings are the most prestigious and most sought after with the most amenities. They usually have professional management, good access, and high visibility on busy streets. They are the key locations that make up high quality real estate.
Class B buildings are generally a little older. They are attractive to investors because these buildings can be renovated back to Class A status through common area improvements. Class B buildings have good quality management and tenants.
Class C buildings offer basic amenities, and are a fraction of the cost of an A or B building. They are usually located in less than desirable locations/neighborhoods. Class C buildings are the lowest grade for usable buildings and typically have higher than average vacancy rates for their market.
Capitalization (CAP) rate is a snapshot in time of a commercial real estate asset’s return. A high cap rate (10, 11, 12%) usually represents a higher risk investment and a low sales price. High cap rate investments are typically found in poor, low income neighborhoods. In comparison, a low cap rate, such as 4, 5 and 6%, usually typifies a lower risk investment but a high sales price. Low cap rates are usually found in upper middle class to upper neighborhoods.
Debt Coverage Ratio
Also known as DCR, the debt coverage ratio is the heart of commercial real estate and financing. It is the amount of cash flow available to pay your mortgage. The formula is your NOI (net operating income) divided by your annual debt. All commercial lenders want you to be able to afford your mortgage, and have funds left over. The DCR tells you how much is left over. A DCR of 1.2 or more is a good place to be in.
Letter of Intent (LOI)
A letter of intent is used in commercial real estate to put the major points of a proposed purchase or lease into writing. It can be used to outline some of the basic, fundamental terms of an agreement before negotiating and finalizing all the fine points and details.
Net Operating Income (NOI)
Net Operating Income assesses the profitability of income-generating real estate investments. The NOI equals all revenue from a property, minus all operating expenses. It can be compared to real estate comps to judge whether it is good or bad.
Purchase & Sale Agreement (PSA)
The purchase and sale agreement is the central document for the sale of a commercial property. It is made after both buyer and seller agree to the terms and purchase price.
Tenants in Common (TIC)
Tenants in Common, or TIC, is an arrangement where two or more parties share ownership in a property. Co-owners can own different percentages of the property, and each owner is given a deed. This is what we specialize in at Millcreek Commercial—it is our goal to break down the barriers that once existed for investing in commercial real estate.
Return on Investment (ROI)
Return on investment is a ratio between net income and investment. It demonstrates the percentage of return that an investor is getting back on the funds that they invested. A high ROI means that the return is favorable in comparison to the cost.
Triple Net Lease (NNN)
NNN lease is a lease structure where the tenant is responsible for paying all recoverable expenses related to ownership. This includes maintenance, repairs, roof/structure, etc. The tenant pays all expenses of the property.
Being familiar with these commercial real estate terms will help you through the investment process and help you to make more informed decisions when it comes to your investment. This is just the tip of the iceberg in regard to all there is to know about commercial real estate—with any questions or concerns, feel free to contact us! 801.899.1943