Understanding The Total Cost of Occupancy
In our experience, commercial tenants tend to focus too much on the ‘face rate’ of a property, AKA the base rent or net rent. It’s not surprising, since the face rate is what’s marketed to attract tenants. However, that rate is only one part of a tenant’s actual Total Cost of Occupancy. When you’re trying to understand the real price for renting a facility, it’s that total occupancy cost that really counts.
For example, let’s look at some rates from our market. For an industrial warehouse, the base rent might be between $4 and $8 a square foot. For office space it might range from $10 to $30 per square foot. Digging deeper, if an industrial client tells me they are paying $7 psf base rent and has put little thought into or can’t outline other costs, I feel confident there are other costs being missed that are much more impactful than a 10% discount to base rent, for example.
However, we can’t let the conversation stop there. It’s our responsibility to uncover every item that impacts cost for our clients. Only then can I really secure the best terms for them for both immediate impact and long term benefits.
To illustrate just how many different factors impact Total Cost of Occupancy, here are four of the most common expenses commercial tenants must consider.
Taxes and Operating Expenses
Taxes and operating expenses can be listed in a number of ways in a lease. Sometimes they are collectively called CAM (Common Area Maintenance) fees, or sometimes they are called the triple nets (NNN). However they’re organized, every building has these fees. They cover costs like:
Taxes
Repairs & Maintenance
Insurance
Management & Admin Fees
How are expenses determined and who pays for them?
Depending on how the landlord operates, fees and expenses may be presented as general estimates or an itemized list. To understand if the number being presented is truly comprehensive, though, consider questions like these:
Is your space separately metered? If so, does that mean you pay utilities directly and that they are not listed in your expense number?
What, if any, expenses does the landlord “pay” but then pass back to you as the tenant?
What are the PM and Admin Fees, and are these capped or can any amount be passed through?
Who replaces HVAC units if they go down and how are costs handled?
How are expense increases managed?
Expenses typically increase year over year in line with (or sometimes more than) inflation. To understand your Total Cost of Occupancy, these potential increases must be factored into your budget. Finding ways to limit these increases or to hold a landlord accountable to keeping costs low is also good for reducing the total occupancy costs.
Expenses can increase unexpectedly in a number of different ways, such as:
Taxes increase and the landlord does not contest them.
HVAC unit goes down and your lease requires you to pay for the replacement.
The landlord initiates a large capital project and pushes your CAM expenses higher to cover it.
The mechanicals in your space are outdated and require repairs or replacement.
You signed a lease for a new building with estimated expenses, but the estimate was inaccurate, leading to actual costs over the next 3 years that are significantly above what was budgeted.
Any one of these by themselves may be manageable. However, if multiple increases begin to stack, or if costs increase repeatedly over multiple years, the burden becomes more significant. I’ve personally helped clients whose actual costs had grown 5%, 10%, and even 20% higher than expected, all of which could have been avoided if more attention was paid to the negotiations up front.
New Building vs. Old Building
Maintenance costs will, usually, be starkly different in a brand new building vs. one that is decades old. Here’s a simple side-by-side comparison of common cost expectations to illustrate why:
NEW BUILDING
New Mechanicals = Lower Repair Costs
New Rooftop Units = No need to replace during initial term
New Dock Equipment = Work can proceed longer with minimal maintenance
Efficient Building Design = Lower Utility Costs
OLD BUILDING
Old Mechanicals = Ongoing Maintenance costs
Old Rooftop Units = Higher risk of replacement or major repair of HVAC Unit(s)
Old Dock Equipment = More frequent work stops for repairs result in higher costs
Inefficient Systems /Building Envelope = Higher Utility Costs
Newer Isn’t Always Better
While everything in the chart above is generally true, a tenant’s individual experience will vary depending on their lease terms and cost exposure. For example, consider a manufacturer that has strict facility cooling requirements. It’s probable that their utility costs would be much higher in a brand new, 32’ clear warehouse vs. an older 16’ clear height facility. Examples like this demonstrate the folly of thinking in absolutes about the relative costs of old vs. new.
To plan against legitimate cost concerns for old facilities, the above table can be used as a blueprint of what needs to be addressed in the lease prior to occupancy. A landlord can be made to repair or replace old mechanicals to brand new or 100% working order, for example. Or they could agree to take on the future cost of repairs and replacements. In short, old building concerns can be negotiated out.
The Importance of Prior Years’ Data
One other perk tenants don’t always consider for older buildings: prior years’ expense data. This data makes them less prone to big shifts in taxes and operating expenses compared to a brand new build. The less data you have for previous years, the more important it is to account for that uncertainty in your lease structure.
Here’s an anecdote to help illustrate.
A business owner we know had moved to a brand new facility. Operating expenses and taxes were low in year one, as the building was both not fully assessed and previously vacant. Still, the business owner knew these would go up. Both the landlord and listing broker had provided estimates for years two, three, and so on, and these were factored into the budget.
Fast forward to year three, and guess what? Those estimates were way too aggressive. Unfortunately, this business owner wasn’t working with us when they signed their lease, or we would have caught the problem just as we’d done for several other clients before.
The consequences? No less than an annual financial oops to the tune of six figures. Even after they thought they’d made a smart facility decision through a thorough and competitive process, this major miss left them paying the price - literally.
Tenant Improvements and Other Concessions
Different buildings handle improvements differently. For example, Building A may offer a large Tenant Improvement (TI) package, while Building B may offer nothing but charge lower rates. To know if A or B is a better deal, you’d need to consider what renovations are needed in each space, and how much of the renovation costs would be covered by TI.
Now let's take that example a step further. Say Building A and Building B both offer $250,000 in TI and charge the exact same rates. One building will still be a better deal than the other, depending on what specifically needs to be done to each space.
In short, when it comes to TI, rough estimates are absolutely not sufficient. It’s critical to have a detailed scope of work, to know what contractor(s) you can use, and everything it will take to complete your project. Any of these elements, miscalculated, can send you way over budget, and significantly impact your Total Cost of Occupancy.
Other common concessions that may impact your Total Cost of Occupancy include:
Free rent
Moving allowance
Low voltage allowance
Convertible TI dollars
Expense caps
Of course, these are just a few of the many concessions potentially available. Different landlords prefer to offer different kinds of packages, all of which impact Total Cost of Occupancy in different ways. An experienced tenant representation broker is your best bet for figuring out which concessions will work for your business.
Facility Use Changes Over Time
Manufacturers in particular may find themselves in buildings that are more ‘flex’ in nature. In other words, they have a higher percentage of finished space versus pure warehouse. Because of this, warehousing and manufacturing tenants need to carefully consider the building they are in and the other types of uses that are or will be present.
Say you have a 3PL or warehousing use and lease space in a building and a new tenant comes in. Depending on the type of use, your expenses may be impacted negatively.
For example, if the new tenant is a medical manufacturer with lots of employees, the requirements for landscaping and parking maintenance may change. This can also then affect the way your property is assessed. Taxes may go higher because of the higher level of use even though your use hasn’t changed and you may be on the hook for your proportionate share of the increased costs. The same may go for other maintenance items where a higher level of finish or upkeep is now performed (even though you don’t require) and again the proportionate share of those higher costs are now your problem.
However, the reverse can also be true. If, say, you are a manufacturer leasing space in a building with more traditional warehousing uses, you may benefit from the lower costs of this less developed space vs. a building filled with other high-usage tenants.
Find the Hidden Factors That Affect Your Occupancy Costs
This article looked at just four ways Total Cost of Occupancy can be affected. There are a lot more long tail items that may be worth considering for your particular business. Hopefully, though, I’ve done enough to show you that there are many different potential cost buckets. To get to the real numbers, you've got to dig deeper.
As your tenant representation broker, Modern CRE will help you answer critical questions with your lease, such as:
What are all of the potential costs?
What concessions are available?
Who pays for what and how are payments handled(amortized)?
If something breaks, who fixes it and who pays for it?
Who pays to maintain everything?
If costs increase, how am I protected?
If our years of experience have taught us anything, it’s that Total Cost of Occupancy is so, so much more than just rental rates. When you work with us we’ll track down every hidden cost and help you negotiate a lease that protects you both now and well into the future.
Choose your next facility with 100% confidence and get in touch with our team today.