For commercial property inspectors, mastering the language of the industry is crucial for success. Knowing key terms and definitions helps improve communication with potential clients, offers insights into the transaction process, and deepens understanding of building classifications and management practices. Whether you’re working with clients, contemplating a lease, or considering a purchase, this specialized knowledge can provide a distinct advantage. This article aims to outline the most common commercial real estate terms that every inspector should be familiar with.
- An appraisal is the financial equivalent of an inspection. An appraisal is conducted by a state-licensed professional that includes an analysis of the property’s value based on market trends and sales in the immediate surrounding area. An appraiser’s written report is required for all property sales. Appraisals are essential for determining fair market values of properties, as well as property tax assessments.
- A broker is a go-between for a purchaser and seller (or landlord and prospective tenant). The property owner generally pays the commission or fee for the broker, who must be licensed by the state.
- Owners will sometimes modify properties based on a prospective tenant’s specs. These tailored improvements, called “build-outs,” are used in advertising for the property as built-to-suit. The owner makes his/her money back based on a long-term lease agreement, possibly one with an escalation clause.
- The maximum amount a tenant is responsible for common area maintenance cost is referred to as a CAM cap. Any expenses beyond this cap are paid by the property owner.
- Capital expenses or cap ex refers to investments made to enhance or improve a fixed asset either by raising its value or extending its lifespan. Unlike repairs, which are accounted for as expenses in the year they occur, capital expenditures are either amortized or depreciated over the asset’s useful life.
- Capitalization rate or cap rate is a percentage used to evaluate the potential profitability of an income-generating property. It is calculated by dividing the net operating income by the property’s purchase price.
- Properties can be categorized by “classes” based on their location, age, building quality, and infrastructure. This categorization if often used for office buildings.
- Class A Building: A top-tier building with rent rates among the highest 30-40% in the market. These buildings are ideally located, easily accessible, and close to many retail and dining options. They are also well-maintained and managed.
- Class B Building: A mid-range building with rent rates falling between Class A and Class C. Located in decent areas, these buildings offer reasonable access and are near a moderate number of shops and eateries. Maintenance and management are average.
- Class C Building: A lower-tier building with rent rates in the bottom 10-20% of the market. These buildings are in less desirable locations and may have inconsistent access. They are close to fewer amenities and are generally not as well-maintained or managed.
- Concessions are benefits offered by the seller or landlord to help close the sale or finalize the lease. Common concessions include paying a tenant’s moving expenses, build-outs, and discounted rent for a period of the lease.
- A building that is changed from one use to another is referred to as a conversion. The space in transition is reclassified from its current category to its future use. (i.e., an office building being converted to an apartment building will be removed from office inventory and included under apartment space, or number of units, under construction).
- Cost segregation is a tax strategy in commercial real estate that accelerates depreciation deductions. It involves breaking down a property into its various components and classifying them into shorter depreciation lifespans, typically 5, 7, or 15 years. This allows property owners to reduce their taxable income and boost short-term cash flow. Components can include elements like electrical systems, plumbing, and fixtures. The process often requires a specialized cost segregation study for compliance.
- Building maintenance refers to the ongoing care, repair, and upkeep of a building’s structural integrity and functional systems. There are three primary types of building maintenance, including:
- Preventative maintenance is a type of maintenance that involves regular inspections, servicing, and repairs aimed at preventing unexpected breakdowns and failures. The goal is to keep equipment, systems, and materials in good working condition and to extend their lifespan by catching issues before they escalate into major problems.
- Corrective maintenance is carried out after a failure has occurred and is aimed at restoring a system or piece of equipment to its operational state. This is more of a reactive approach and involves repairs or replacements that happen after the fact.
- Predictive maintenance is a strategy that uses data analysis, monitoring tools, or performance metrics to predict when a machine or system is likely to fail. By identifying potential issues before they happen, interventions can be planned and scheduled to minimize downtime and costs.
- A REIT (Real Estate Investment Trust) is a company that owns or funds assets that generate income, including residential complexes, malls, office buildings, and storage facilities. It may also invest in non-income-producing assets like air or water rights, uncollected crops, or specific structural elements of a building. REIT shares are tradable similar to stocks, providing shareholders a way to engage in the real estate market.
- The rental agreement for a commercial property is commonly referred to as a lease. The owner is considered the lessor, and the tenant is known as the lessee. The lease generally stipulates the length (or term) of the lease, the rent and due date each month, and other general terms of occupancy, as well as specific prohibitions or responsibilities of the tenant. It’s important that the tenant understands what his duties and financial responsibilities are for the property, and which ones are his landlord’s (such as property and component maintenance, etc.) before signing the document. Additionally, there are a few different types of lease agreements that use alternate formulas for arriving at the amount of monthly rent:
- A flat lease (or straight lease) stipulates the flat amount of rent for the entire length of the lease, along with any renewal date, in which case the terms of the lease (including the rent) may change.
- A percentage lease uses a percentage of the tenant business’ net or gross sales to help determine the monthly rent. This is a popular type of lease used for commercial retail properties, and the percentage of sales is charged in addition to a minimum base rent.
- A gross lease is a lease in which all expenses associated with owning and operating the property are paid by
the landlord. Also see net lease.
- A net lease -– also referred to as a “triple net” or “net-net-net” lease — requires the tenant to pay additional fees on top of the basic rent. These fees may be for property taxes, maintenance, insurance, etc. Prospective tenants should especially note if there is an escalation clause in the lease. This allows the landlord to raise the rent based on any number of factors, including cost-of-living increases (based on a percentage as determined by the state in which the property is located), or planned or unexpected expenses during the term of the lease.
- Some commercial property owners allow a tenant to sublease a portion of the property, especially if it is larger than the tenant needs. The tenant is still responsible for the terms of the lease agreement. It’s the equivalent of the tenant taking on a roommate, or becoming a landlord himself. It’s always advisable for the primary tenant to make sure that his sublessee’s business or occupancy is complementary to his own, including hours of operation, number of employees, whether there is adequate parking, noise barriers, shared kitchen and/or restroom accommodations, etc.
- Turn-key properties are move-in ready, with little or no modifications or build-outs required in order for the tenant to commence business almost immediately upon occupancy.
In summary, the commercial real estate industry is filled with specialized terms that property inspectors need to understand. From appraisals to building classes, and from lease types to maintenance practices, these terms are more than jargon—they’re essential tools for effective communication and decision-making. Knowing the significance of terms like CAM cap, build-outs, and capitalization rate can greatly enhance an inspector’s credibility and effectiveness. Whether you’re evaluating a top-tier Class A building or a conversion project, this comprehensive list of terms serves as a valuable resource.
Additional Resources for Commercial Property Inspectors: