Most companies don’t realize that out of all operating expenses, real estate is the second-highest cost. Real estate tends to fall right behind human capital and is always a significant item on the balance sheet. Typically, companies don’t spend a lot of time evaluating their real estate. Nor do they necessarily understand the impact real estate has on many areas including recruiting and retaining top talent, and the bottom line.
Real Costs in Real Estate
I was in the crowded elevator, smashed in the rear corner, trying to beat the lunch rush like everyone else downtown. I overheard a middle-aged man with salt and pepper hair talking to a short guy next to him about his office space. He said that he just got an amazing deal at $28.00. He seemed proud, even bragging about his accomplishment. The guy next to him asked if they reconfigured the space and he said no, they like it just the way it is, so why change it? And then the elevator opened, and their conversation was muffled with the crowd.
I love hearing people talk about their office or industrial lease. But as the crowded elevator emptied, I wanted to chase after the salt and pepper haired guy to share with him that he did not get a good deal. As a matter of fact, he got a terrible deal. You see, commercial real estate leases are not recorded, so the average consumer has no way to know what they should actually be paying for space. In addition, many factors go into a commercial lease, not just rent.
The Top Three Factors That Impact Your Real Estate Lease and Operating Expenses
First, when businesses evaluate the face rate alone, they are not seeing the true costs. Leasing rates are quoted in many different ways such as full service, gross, net, triple net, industrial gross, etc. Each one of these means something completely different and needs to be accounted for when looking at total operating expenses.
Second, a multi-tenant office building has a loss factor which equates to a tenant paying for a certain amount of rentable space which includes common areas such as hallways, restrooms, a lobby and elevators. However, their actual useable space where they do actual work could vary. The rentable vs. useable number can range significantly and a tenant in one building with a high loss factor could pay much more money to fit the same amount of people in another building with a lower loss factor.
The third factor is the TI (Tenant Improvements) allowance. Most office and industrial Landlords will provide the tenant a TI Allowance to build the space to suit their specific needs. In many cases, this allowance is below a finished ceiling (that is a huge cost by itself) which allows the tenant to build the walls, doors, kitchen, framing, electric, plumbing they need. Some Landlords are willing to turnkey the space as well which means based on your drawing/space plan, they will build the space, and hand you the key to move in. The majority if not all of this cost should be borne by the Landlord, not the Tenant.
We had just done a deal in this same building at $24.50 net electric with a $30 per RSF tenant improvement allowance. Based on the floor he accessed the elevator from, he is with a law firm around 15,000 sq.ft. In size. If he is paying $28.00 per RSF then he is paying $420,000 per year in rent and over a 5-year term that equates to $2.1mm. That same tenant when leveraged in the marketplace is paying $24.50 per RSF totaling $367,000 per year and $1.8mm over the term. The savings is almost $200,000.
The Leverage to Help Reduce Operating Expenses
How we create leverage is simple. We only represent the tenant, never the Landlord so we are in the market with many clients evaluating buildings constantly. We know what rates and terms are being proposed and being accepted. We have access to data that shares underlying mortgage data on the assets to know a landlord’s financial position and how aggressive they can be. We go through a proven lifecycle process with each of our clients to ensure they’ve evaluated each and every option that meets their needs. Every short-listed property goes through our request for proposal process and the options are presented in an apples-to-apples comparison. Business leaders can then see the net present value and cash flow basis for each opportunity. In many cases, we are able to leverage a smaller deal with the terms of one of our larger deals. There’s a good chance someone from our team has already done a deal in your preferred location and we know what to expect.
Real estate is fluid. It rapidly changes with the ebb and flow of the economy and the market sectors it supports. In Pittsburgh, we are known to be a stable market driven by education and healthcare which means our leasing rates tend to not change drastically during a recession. Pittsburgh’s office market is around 130MM square feet and if you have a lease coming up, you should take the time to evaluate all of your options. Every business should have a broker who knows the market, helps reduce operating expenses, and advocates for them by creating leverage for their tenancy.
When a Landlord leases a building, they agree to pay a commission. The tenant broker just shares the fee that is already being paid. You don’t save money by not using a broker to advocate for you. In almost every scenario you save not only money but time, when you work with a tenant broker. Not to mention, your shareholders feel like you’ve made an informed and educated decision. Learn more about how we can put you in the best position and reduce your operating expenses.
Assessing your lease, thinking about relocation, or strategizing your return to work plan? Contact us today to learn more about how we can help you create leverage in your commercial real estate negotiations.