Fundamental Concepts in Real Estate (Part I)

If you’re a beginner to the world of real estate, there are a few concepts that you must know. These are crucial. I’ll try to explain them in simple, layman’s terms for you:

Real Estate: The true definition of “real estate” is land or any fixed improvements on that land. 

Rents: This is what tenants pay to occupy space.

Tenants: A person or entity that, with respect to the law, occupies the space from the owner/landlord of that piece of real estate.

Landlord: A person or entity that, with respect to the law, owns the building, land, or piece of real estate.

Air Rights: An interest in the vertical “air space”--basically goes up to the sky that is above land.

FAR: Floor area ratio or FAR is the total amount of space (measured in square footage) that can be built on a plot of land.

Potential Gross Income: Also known as “Gross Potential Income” or “GPI”, it’s basically the rental income that the Property would produce if the space were 100% occupied at market-competitive rents.

Effective Gross Income: Calculated by taking the “Potential Gross Income” and adding in other non-rental income at the property (such as reimbursements, parking income, amenities income, etc) and adjusting/subtracting for vacancy and credit loss.

Reimbursements: Leases can be structured so that the tenant has to reimburse the landlord (thereby sharing in the costs) for certain operating expenses. Typical lease reimbursement types are NNN (triple-N), Full-Service Gross, or Modified Gross.

Vacancy: How much space at the property isn’t occupied.

Credit Loss: Not all tenants pay on-time or pay as they should. Usually, credit loss is modeled at 1.0% of the Effective Gross Income.

Operating Expenses: Expenses incurred as a result of the operations of the Property. Can be broken into fixed & variable operating expenses. Fixed operating expenses include costs such as real estate taxes and insurance. Variable operating costs include costs that vary with the occupancy of the property, such as utilities, and repairs & maintenance expenses. 

NOI: Calculated by taking Effective Gross Income and Subtracting Operating Expenses.