Commercial Real Estate Terms to Know
I'll start off by saying that I am not a real estate agent, and I don't pretend to be one. This is all information I learned during the course of staring my own practice. I've tried my best to distill the terms I found most confusing into easy-to-digest pieces. The goal of this post is to help you understand the difference between different types of leases so that you can appropriately compare competing real estate offers.
There are three basic types of commercial real estate leases: gross, modified gross, and triple net. A gross rate means that your rent includes all expenses needed to operate the property. A modified gross rate includes some, but not all of these expenses. A triple net (NNN) rate does not include any expenses related to operating the property. Let’s examine these in a little more detail.
Gross Rent
When I was looking for practice locations, the least common kind of rate I encountered was gross. A gross rate is analogous to the rent you would pay to a landlord for an apartment. The apartment owner assumes the cost of all operating expenses (property taxes, property insurance, and maintenance). You must still pay for your Internet, phone service, utilities, etc. Some gross (and some modified gross) leases include utilities such as electric, water, sewer, etc but not all.
Modified Gross Rent
As the name implies, a modified gross (MG) lease means that the property owner will pay for some, but not all, of the operating costs. The most common cost not covered is maintenance. Most of the properties I toured and proposals I negotiated were for MG leases of some form. Interestingly, in my part of the Midwest, even the MG leases commonly included the cost of daily janitorial services and maintenance.
Triple Net Rent
In a triple net (NNN) lease, the tenant assumes responsibility for the cost of real estate taxes, property insurance, and maintenance. I found this type of lease to be most common in class A buildings. Commercial real estate buildings are classified into categories A, B, C, etc based on age, amenities, location, and more. In general class A buildings are the newest, have the most amenities, have the most desirable locations and cost the most. I found that class A buildings typically offer only NNN leases as rentable square feet rather than usable square feet.
There are pros and cons to each type of lease. In both types of gross lease, there is a risk of the landlord overestimating the cost of property taxes, maintenance, and property insurance. These estimated costs are baked into your rent in both G and MG leases. Generally, the asking price per square foot is a little higher for G and MG leases for this reason. When evaluating real estate proposals, I recommend calculating your best approximation of the total cost of renting monthly (for cash flow purposes) and over the course of the term. Determining the entire amount you will be paying to the building owner is helpful for negotiation purposes - it helps you compare like properties more fairly.
Rentable vs usable square feet
The difference between rentable and usable square feet is very important. Usable square feet is the more intuitive way of looking at a commercial property (from a renter’s perspective anyway). Usable square feet is the specific area the tenant will occupy in order to do business. If you have a partial-floor lease, all office space, storage rooms, private bathrooms, columns, etc are included. A full-floor lease will include all common areas specific to that floor except stairwells, elevators, etc. Some floor-specific common areas may be a bathroom, reception desk, or other pre-existing structures.
Rentable square feet, on the other hand, takes into account the cost of all common spaces in the building. This includes corridors, stairwells, common conference rooms, etc. Each tenant pays for their share of common spaces calculated by the proportion of space they lease in the building. There are two important equations to know here. The first is how the load factor is calculated. Load factor is the percentage of common area in the building.
Load factor = building rentable square feet ÷ building usable square feet
For example, in a 100,000 square foot building with 90,000 usable square feet (10,000 square feet of common areas) the load factor is 1.10.
100,000 rentable square feet ÷ 90,000 usable square feet = 1.10
The load factor is then multiplied by the usable square feet to determine the total rentable square feet. A typical load factor varies by locality, but tends to be on the order of 1.10 to 1.25 (10% to 20%). For example, if a company is interested in leasing 10,000 usable square feet in the example building above, the total rentable square feet they would pay for is 11,000 rentable square feet.
10,000 usable square feet * 1.10 = 11,000 rentable square feet
When evaluating leases, it is critically important to know the load factor and calculate your actual rental costs in order to have a fair comparison between competing leases. The load factor will commonly be quoted as a percentage. Let’s look at some examples to help make sense of all this.
Let’s say you’re looking at starting your practice and want 2,000 usable square feet. You’re evaluating a lease from three different buildings and they all quote $10 per square foot.
Building A calculates rent as usable square feet.
Total annual rent = 2,000 usable square feet * $10/square foot
Total annual rent = $20,000
Building B calculates rent as rentable square feet with a load factor of 1.15 (15%).
Total annual rent = 2,000 usable square feet * 1.15 load factor * $10/square foot
Total annual rent - $23,000
Building C calculates rent as rentable square feet with a load factor of 1.25 (25%).
Total annual rent = 2,000 usable square feet * 1.25 load factor * $10/square foot
Total annual rent = $25,000
If buildings A, B, and C are all equally acceptable, the choice of Building A is clear. However no two buildings are exactly alike and your decision will come down to a combination of location, amenities, and cost. Calculating the total actual annual and monthly cost will help compare competing lease offers fairly.
A final note on office space measurements. In a perfect world, all landlords and leases would utilize the Building Owners and Managers Association International (BOMA) standards for measuring buildings. These standards ensure that spaces are measured appropriately. Some landlords/building owners have been known to deviate from these standards and accidentally include parts of hallways in usable square feet calculations. Such errors are unfortunately common, and bringing a tape measure or hiring an independent professional to verify usable square feet may be a good idea. I would recommend hiring an independent professional if you are renting a large amount of space. For smaller spaces, the monetary difference is minimal and measuring yourself may be enough. If you don’t want to make the leasing agent stand around while you measure each room, it’s good to know that a standard office ceiling tile is approximately two feet by two feet. This estimation can give you an idea of whether the measurements on the floor plan you’re provided are reasonable.
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