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If you’re ready to make the leap to commercial real estate, you’re poised to make great money. That is, if you know what you’re doing. In our continuing series, we examine the basics of buying commercial real estate, along with tips for the process.
Just as with residential real estate, commercial real estate has a language all its own. To prepare yourself for an effective investment, one that will be lucrative and beneficial for years to come, you first must understand the lingo.
Commercial real estate properties, including office space, industrial facilities, and retail units, are measured in square feet. Measurements can be made in two ways:
Gross square feet: The sum of the areas at each floor level. This includes all stories or areas that have floor surfaces with clear standing head room (6 feet 6 inches minimum). It also includes cellars, basements, mezzanines and other rooms regardless of their use.
Net square feet. The sum of all areas within the perimeter walls of the unit. This is measured to the inside faces of the walls, and includes all columns, shafts, ducts and risers, whether separately enclosed or not.
While apartments, hotels and self-storage facilities can be measured in square feet, they’re more commonly measured in units or rooms.
Commercial real estate properties are identified by their address, along with the particular city and state. Additionally, they are identified by the submarket.
Submarkets in larger cities are often neighborhoods. In Chicago, for example, submarkets might include The Loop, Hyde Park and Wrigleyville. In other areas, submarkets are regions. In Nothern California, for example, submarkets include Silicon Valley.
Ownership of a commercial property can take many different forms, all dependent on the roles the owner plays. A lease refers to this ownership agreement.
A traditional office lease is a gross lease. The property owner is responsible for virtually all costs related to the leased space, including taxes, insurance, water, power costs and more. Some office tenants, and most industrial and retail tenants, pay a net lease. In this case, the tenant is responsible for the costs related to the space.
It all comes down to the return on investment that the buyer of commercial real estate receives.
The cap rate is the initial annual return that can be expected. It’s calculated by dividing the purchase price by the projected net operating income for the first year of the investment. For example, if a building sells for $10 million and generates $1 million of projected net operating income, the cap rate is 10%. Real estate buyers and investors can use cap rates to compare the returns of their real estate holdings to the performance of other types of investments, such as stocks and bonds.
Read our additional articles in this series for guidance through the commercial real estate purchase process, including types, methods for obtaining commercial loans, and more.
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