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Why commercial real estate rental rates are poor indicators of total occupancy cost

February 8, 2018 Article 2 min read
Ron Gantner Plante Moran Realpoint

When evaluating a commercial real estate decision, many tenants naturally focus on the lease's rental rate. Rental rate is important, but that one number alone cannot truly describe which space is a better deal.

Empty, open office space

I always say real estate is a math problem. When evaluating a real estate decision, many tenants naturally focus on the lease’s rental rate to determine which space is a better deal. A lower rate equals a better deal, right?

Unfortunately, it’s not a simple as that. Rental rate is an important factor, but it alone does not describe the true amount you’ll be paying to occupy a building or space. Before you go with the lowest bidder, you need to figure out the total occupancy cost associated with leasing each building or space option.

Rental rates: Only part of the total cost equation

Comparing the cost of your commercial space options involves more than just cost per square foot. Understanding what’s incorporated into your base rent is important for both determining your total occupancy cost and avoiding unexpected costs that fell outside the scope of the negotiated rent price.

Costs within the base rent: What counts and what doesn’t?

Commercial leases have several basic structures that affect which costs landlords amortize into the base rent and which are separate line items.

Industrial and retail space users usually sign a single-net lease (N) or triple-net lease (NNN), which typically keeps extraneous costs outside the base rent number. Office transactions usually involve a modified gross lease or full-gross lease, where many of the costs are rolled into the base rent.

A tenant representative can help you determine the most effective lease structure to mitigate extraneous occupancy costs.

Details like these may make or break deals that cost the same per square foot, and many of these details — once identified — can be negotiated to improve the deal.

When comparing locations, tenants should analyze items such as:

  • Utilities
  • Taxes
  • Insurance
  • Build-out allowances
  • Janitorial costs
  • Common areas maintenance (CAM)
  • Landlord concessions
  • Building procurement costs
  • Capital repair expenses

Depending on your situation, you may find it beneficial to negotiate dollar amount caps to these costs or opt for a slightly higher base rent in exchange for the landlord taking on expenses that qualify as building operating costs. A tenant representative can help you determine the most effective lease structure to mitigate extraneous occupancy costs.

Space efficiency: Another variable to factor in

Space efficiency also factors in at this point. One space may cost $5 more per square foot than another but be a 20 percent more efficient space, making the seemingly more-expensive space in actuality a much better deal once you look at factors outside of the cost-per-square-foot rental rate.

It all comes down to the big-picture question, “What am I paying to be here?”

Knowledge is power: Solving for the long-term cost of your real estate transaction

To figure out what works best for your organization and get the best real estate deal you can, talk to your tenant representative about your options and negotiating power. If you’re currently in a lease, consider having your representative review your reconciliation statement to be sure you’re not overpaying your landlord for your share of the charges.

This mistake is one of many commonly missed items during a real estate transaction. To learn about other overlooked factors, download our e-book, “The 10 things most executives miss in a real estate transaction.”

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