It’s assumed that determining the
expense of leasing property involves a
simple calculation of multiplying your base rate times your square footage. In
reality, the total cost of occupancy includes
many additional expenses that can dramatically increase a company’s real estate expenditures. If you don’t understand all of
the factors or work with a real estate adviser that does, they could cause a significant
impact on your earnings and cash flow.
“Many companies make the mistake of
focusing on the lease rate to determine
their costs.” says David Salazar, senior vice
president with CresaPartners LLC in
Orange County. “They think they’ve negotiated a great deal, but they don’t understand
that the total cost of occupancy includes
several additional factors.”
Smart Business spoke with Salazar
about some of these hidden costs and how
to anticipate and minimize them.
What are the main fixed costs associated
with leasing?
A number of fixed costs contribute to
total leasing costs. To start, companies pay
the base rate for the square footage they
occupy, called usable square footage. In
addition, a ‘load factor’ is added that determines the total rentable square footage.
The load factor is the difference between
what the tenant actually occupies plus an
allocation of the common area square
footage, such as corridors and the lobby
area. The tenant then applies the rental
rate to the total rentable square feet.
Also, if a property owner does not pay for
all the construction costs for the build out
or reconfiguration of the space, the tenant
will have to pay the difference or ask the
owner to amortize the difference into the
lease rate, adding additional monthly costs.
Finally, a rate escalation may occur on
the base rate on a periodic basis. The escalation may occur on an annual basis or
some other interval that is negotiated.
What variable costs apply to leased real
estate?
When deciding on a building, companies
need to keep operational expenses in mind. For instance, as electrical and water
expenses increase, they will be passed on
to the tenant. Another variable cost could
be a change in ownership. Every time an
investor sells real estate, the government
reassesses it. Taxes increase because of
the higher assessment, and these costs
pass through to the tenant. Other variable
expenses may include:
- Parking costs, reserved and unreserved
- Insurance costs
- Capital improvements
- Property management fees
An adviser can audit the sometimes
vague charges to ensure accuracy and
appropriately reflect the tenant’s responsibilities.
How can companies calculate the total cost
of occupancy (TCO)?
There are several methods for calculating
your TCO, with the following formula providing the basic pieces:
Base Rate (+ Escalations) x Size (+ Load)
+ Expenses (parking, electrical, etc.)
+ TI Amortization
= TCO
The most common way to calculate the
potential leasing expense is to determine
the ‘effective rate’ over the term of the
lease. The effective rate is the average rate
paid over the term after taking into consideration factors such as free rent and rate
escalations. Rate escalations can either be
fixed or be tied to an inflation index, such
as the Consumer Price Index.
What other hidden costs contribute to tenants’ expenses?
Businesses should be aware of clauses
that include the following;
- Capital expenditures: Many times, a
landlord will build a new lobby or outdoor
fountain and try to pass the cost on to the
tenants. Tenants should not have to pay for
capital expenditures. - Management fees: Tenants need to pay
standard property management fees, but
sometimes managers will add additional
charges for functions such as managing
construction projects. Such expenses may
not be appropriate. - Early termination fees: Even if a lease
allows a business to terminate prior to the
lease expiration date, it is critical that a tenant understand the penalty involved, which
may include unamortized commissions
and tenant improvements. - Hold-over costs: If tenants delay moving out of the building at the end of the
lease, they should beware that penalties
can be as high as 150 percent of the last
month’s rent.
They key to understanding your total cost
of occupancy is to retain an adviser that
specializes in representing tenants/users of
space and has the knowledge and experience in negotiating leases before they are
signed.
DAVID SALAZAR is senior vice president with CresaPartners
LLC in Orange County. Reach him at (949) 706-6600 or
[email protected].
