The rent being offered for office space is generally not what comes out of your pocket. A property may have a listing price of £30 per square foot but service charges, taxes, utilities, insurance and fit-out may increase the cost. The useful number represents your all-in cost of occupancy, when compared to the revenue the location can realistically support. Work out that prior to comparing buildings.
Start With the All-In Occupancy Cost
Base rent is for the use of space. All in occupancy cost is any cost that has to be incurred on a regular basis or at the start-up for the business to operate there. This can range from property taxes or business rates, common area maintenance, insurance, security, parking, cleaning, repairs, legal costs, fit out expenses and more depending on the lease.
Suppose the base rent of an office is £4 000 per month. The monthly occupancy fee amounts to £5,800 with a service charge of £750, taxes of £500, utilities of £350 and insurance/cleaning of £200. The actual annual rental charge is £69,600, rather than the headline charge of £48,000.
Request a written listing of all charges and how each can be raised. Even if the landlord reconciles the estimated charges at a later time, they should still be considered as costs in a realistic budget.
How Commercial Rent Per Square Foot Is Calculated
The amount of commercial rent is typically given in terms of an annual charge per square foot, but this varies by area. To estimate monthly base rent, multiply the quoted rate by the rentable area then divide by 12. The cost of a 1,500 sq ft office, at £32 sq ft per year would be £48,000 per year, or £4,000 per month.
Verify if the quote is based on square footage that can be used or leased. Useable Space is the space that your business takes up. Rentable space can include a proportion of corridors, lifts, toilets, lobbies etc. and common areas. If you use 1,500 square feet but pay for 1,725, a £32 rate produces annual base rent of £55,200.
Check out a professional floor plan before signing. If you pay £7,200 extra a year, due to a slight misunderstanding of the area you’ll be more than compensated for any small discount on the advertised price.
Gross Lease vs Triple Net Lease
Whether the property costs are included in the rent depends on the lease structure. A full-service gross lease typically involves the landlord covering most of the operating costs of the building and in many cases paying a lump sum rent amount, as listed in the contract. In a modified gross lease arrangement, the landlord and tenant split the cost of the rent.
Triple net lease (also known as NNN) is a type of lease in which the tenant is responsible for paying base rent and a portion of property taxes, building insurance, and common area maintenance. If the shop quoted a £24 per square foot lease, this may be less expensive than a gross lease at £31 per sq ft, but if the NNN lease is £9 per sq ft of NNN, then the cost of the lease will be £33 per sq ft before utilities.
This isn’t enough since leases with the same “label” may distribute the costs differently. Read the expense clauses and ask questions about the expense calculation of the last 3 years. Property management fees can be included in operating costs, so check to see if there are limits on them.
How Much Rent Can Your Business Afford?
Unfortunately, there is no foolproof percentage that works for all businesses. A law office with lots of money per square foot can afford to pay more rent than a retailer with a low margin or a warehouse. The first step is to determine the occupancy cost ratio: annual occupancy cost / annual revenue from the location.
If the expected annual sales for a shop is £800,000 and all in occupancy costs are £80,000, the ratio is 10%. The shop has a gross margin of £280,000 at that 35% rate, which is before salaries, marketing, administration, debt and rent. Although the £80,000 occupancy cost is just 10% of sales, it is 28.6% of gross profit and is difficult to swallow.
Test the location with the income statement formula under normal, weak and strong sales scenarios. If a business is looking to generate £50,000 per month, it should consider if it can cover the monthly expenses of £7,000 if revenue drops by 20% to £40,000.
Budget for Fit-Out and Other Hidden Costs
Typically, the cost of renting commercial property is higher than that of renting residential property and often they need a larger deposit and rent for their first month. A big initial bill can come from the legal review, surveys, permits, furniture, cabling, signage, equipment, moving, and accessibility requirements, to name a few.
A £90,000 improvement is required for an office that needs to be improved for 2,000 square feet for the opening. Including a £15,000 deposit, £6,000 in professional fees and £12,000 in furniture and technology, the amount of cash needed is now £123,000. This equates to an economic cost of £1,500 per month if spread over a five-year period, for £90,000 of fit-out work.
Some rent payments for the use of property in a trade or business might be deductible as a business expense under federal tax rules, but deposits, improvements, prepaid rent, and purchase-like arrangements can be treated differently. A small business loan can be used to finance the transition, but payments have to be included to the affordability equation.
Compare Effective Rent, Not Headline Rent
The economics of two offers may be different when one landlord offers a different incentive. Spreads free rent periods, cash contribution and other incentives evenly throughout the lease instead of counting them at first or last of the lease.
Let suppose that the cost of rental of the office A for 5 years is £60,000 each year, including 6 months free. Total scheduled base rent is £300,000, less £30,000 of free rent, leaving £270,000 or £54,000 per year before increases. The cost of Office B is £56,000 per year with no free period so the total cost for 5 years is £280,000. Before fit out and service charges plus escalation, Office A is £10,000 cheaper.
Even if you’re paying free rent, you could still have to pay service charges and utilities. Verify when payments will start and if there will be a repayment amount if you terminate/fail to pay on time.
Negotiate the Risks, Not Just the Starting Price
A small decrease in the rent in the first year might not be worth it compared to flexible terms. Be particularly attentive to the rent review formula, caps on controllable operating costs, who is responsible for maintenance, the right of assignment, renewal options, personal guarantees, restoration requirements and the right to terminate early.
Imagine that the rent for a property is £50,000 per year and increases by 4% each year. In year five it is approximately £58,493 and the sum of all rents over five years is approximately £270,816. The rent will be around £54,122 per year in year 5 and the total rent over 5 years will be approximate to £260,204. That clause raises the commitment by over £10,600.
If a lease ties are increased to an index, the formula needs to specify the index, dates which the increases apply to, the reference periods, and how revisions are treated. BLS recommendations for escalation clauses emphasize the importance of using an explicit formula and stating the way the selected index will be used. When the lease involves a personal guarantee, place your savings, or home at risk, consider having a commercial property lawyer review the lease before signing it.
The Bottom Line
Estimate the full cost of occupancy before determining if commercial space is affordable. Verify billable space, lease design, operating costs, fit-out cost, annual escalations, and exit costs and apply conservative revenue. Use effective rent to compare offers and compare to financial goals. Only sign when the business can sustain the space in a lean time without relying on ultimate growth.
Frequently Asked Questions
What is the cost of commercial rent per sq ft?
The commercial rent depends on the city, neighborhood, quality of the building, type of property, structure of the lease and local demand. Calculate the annual rate per square foot and multiply by the rentable area, then add in the service charges, taxes, insurance, utilities, and other tenant expenses.
What percentage of revenue should commercial rent be?
There is no universal percentage that is applicable to all industries. Calculate all-in annual occupancy cost for the facility and divide it by the revenue that can be generated by that location and test gross profit can be generated to cover payroll, marketing, debt, and other operating expenses.
What is included in commercial rent?
It depends on the lease. Sometimes the base rent does not include business rates or property taxes, insurance, maintenance, utilities, cleaning, parking, repairs or management charges, so ask for a full written cost schedule.
Discamiler:
This article is for general informational purposes only and does not constitute financial advice. Please consult a qualified financial adviser for guidance specific to your situation.
