By Layne McBride

Let’s be honest – commercial real estate (CRE) has a language all its own. If you’ve ever sat through a meeting and heard terms such as “cap rate,” “TI,” or “absorption” tossed around while nodding along and planning to Google them later, you’re not alone. Whether you’re new to the industry, working in a support role, or just curious, understanding some basic lingo goes a long way. This article breaks down eight of the most common CRE terms – explained in casual language. 

Cap Rate – Capitalization Rate

Cap rate is similar to interest on a savings account; it is a ratio used to evaluate the potential return you could expect from buying a property based on the income it generates. For instance, if a building costs $1 million and has a net operating income (NOI) of $100,000 annually, that’s a 10% cap rate. Seen in the market today, the average cap rate is roughly 7%, but varies based on the location and quality of the building, as well as the tenants that occupy it.

Why it matters:

Cap rates help investors compare deals based on the return on the investment. Lower cap rates usually mean lower risk and lower return – common in hot markets with long-term leases, reliable tenants, and good locations. Higher cap rates may indicate more risk but the potential for greater reward. 

TI – Tenant Improvements

When a tenant moves in, they often want to customize or specialize the space to better fit the needs or wants of their business. For instance, a tenant might want new walls, lighting, flooring, or branding. The cost of these improvements is usually split between a tenant and landlord – landlords provide TI allowances, giving the tenant a certain budget to use to retrofit the space to their needs. The tenant is responsible for paying anything above and beyond what the landlord is willing to contribute. 

Why it matters:

This can be a crucial negotiation point in lease deals – how much the landlord is willing to spend changing a space could influence whether the tenant signs. Landlords are more willing to fund improvements that add long-term value – like adding a bathroom or upgrading lighting.

Triple Net (NNN) Lease

A Triple Net Lease is like renting an apartment and also paying your pro-rata share of the property taxes, insurance, and maintenance. A NNN lease includes those three extras – called “nets” and also referred to as “operating expenses” – on top of the base lease rate. The “nets” are property taxes, property insurance, and any common area maintenance (CAMs), which are variable from year to year. It’s the standard of leases in this market, common in office, retail, and industrial buildings alike. 

Why it matters:

The operating expenses in a building vary from year to year in a NNN lease, tenants are responsible for paying for the actual annual expenses that are generated. So if property taxes or insurance increases, so does the tenant’s rent. It protects landlords from rising costs or increases in expenses that are out of their control. While it is usual that these expenses increase year-over year due to inflation, if they drop, so does the tenant’s rent. 

Absorption

This refers to how much commercial space is being leased or filled in a market over a period of time, typically one year. For instance, if there are 100 spaces available and 70 of them get leased or sold over the time period, the absorption rate would be 70%. If more spaces are filling up, that’s positive absorption. If tenants are moving out faster than new ones are moving in, it’s negative absorption.

Why it matters:

Absorption rates indicate whether the market is hot or slowing down, as well as how many leases are being signed each year. Brokers and investors use this to gauge supply/demand and inform strategy.

Core and Value-Add Investments 

These terms describe different types of investment strategies, based on risk and potential return. 

• Core – a stable, high-quality building/investment, with good tenants, in a great location. Safe and reliable, but typically not as high of returns as other types of investments.
• Value-Add – a property that may need improvements or re-leasing to increase income. May initially be high vacancy, but offers the opportunity to update the space to increase its value tremendously. More risky, but also potential for higher returns. 

Why it matters:

These distinctions between investments help investors decide how bold or risky they want to be with their money. For instance, some investors target value-add investments for more upside.

Anchor Tenant

An anchor tenant is a big-name tenant that draws people in – like a large grocery store in a shopping center with surrounding retail tenants. Their presence boosts traffic and makes smaller tenants want to lease nearby due to the activity they generate. Anchor tenants can exist in both shopping centers and offices, such as Google drawing tech companies to a tech hub. 

Why it matters:

Anchor tenants drive demand and activity in particular areas, as well as offer a built-in customer base, increasing the value of the entire property and helping smaller spaces around them get leased.

Build-to-Suit

Instead of leasing an existing space, sometimes a landlord builds a property from scratch specifically for a certain tenant. Think of it as similar to a custom home, but instead it’s a custom office, warehouse, or retail space. The landlord will build out the space exactly to the specifications of the tenant, and the tenant pays a lease rate that covers the cost of the build-out over time, in essence paying for the improvements via rent payments. This typically results in long-term leases that are securitized, meaning that the landlord is guaranteed something in return in case the tenant ends up going out of business. 

Why it matters:

Deals that are build-to-suit often simplify things because the tenant does not have to go through the process of building out their own space, meaning it is a way to increase a tenant’s interest in the space by taking tasks off their plate. The benefit to the landlord is investment in a good tenant via a long-term lease rather than building spec and hoping you can attract a tenant afterwards.

LOI  – Letter of Intent 

A Letter of Intent is the initial process of negotiating a lease or sale; it is non-binding nor contractual, but it lays out the basic terms of what both sides are agreeing to. A LOI typically includes the square footage of the space, lease rate, term, TI allowance or any other incentives, start date, tenant’s use, and rights to sublet (among other things). Once the main deal points are negotiated in the LOI, then the process moves to a lease or purchase agreement. LOIs are drafted by the tenant or buyer’s broker, and serve as a common way to start a conversation between a tenant or buyer and a landlord or seller. 

Why it matters:

A Letter of Intent saves time by setting expectations early on and nailing down important business or deal-breaking points before diving into a formal lease or purchase agreement. 

Still Lost? Never Be Afraid to Ask

Everyone starts somewhere, and commercial real estate is full of abbreviations and terms that even veterans sometimes have to double-check. The key is not being afraid to ask questions, and surrounding yourself with people who are happy to provide helpful explanations.

The more you understand the language, the more confident you will become in conversations, meetings, and negotiations. In CRE, the more you speak the language, the more you are a part of the deal. 

Have a term you’re stuck on? Message The Colorado Group – we’re happy to explain, no jargon attached.