WHY OPERATING EXPENSES VARY FROM PROPERTY TO PROPERTY?
Have you ever wondered why operating expenses vary from property to property? Energy consumption, service levels and service contracts can vary greatly so it is advisable to secure the details prior to lease execution.
Expenses May Vary
Paramount has been involved in several recent office lease transactions. Many, highlight the need for a close review of the property’s operating budget. Some “full service” leases may include daily cleaning, vacuuming, replacing light bulbs and cleaning your breakroom. And then others may not include these services at all or the services may be on a more limited basis.
Most property owners reserve the right to change rules and regulations and janitorial specs. It’s a good practice for your representative to take the time to request the budget and janitorial specifications. Once you have the detailed information you will be better able to compare properties. After settling on your most desirable property, a close review of the associated lease language is advisable. Although, this may uncover conflicts or missing details that might surprise you during your term. As an example, say your employees prefer to eat lunch in your office suite. As a result, this practice most likely makes it imperative that janitorial specifications would include daily trash service. No one wants to smell that reheated salmon the first time let alone the rest of the week!
Knowing the service level upfront will allow you the opportunity to verify the details are incorporated into the final lease. After all, operating expenses and real estate taxes can be 50% or more of your overall rent and you should only be paying for services you receive.
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Or reach out to one of our Trusted Agents:
Office Agents: Nancy Powell, Vice President | Jeffrey Swanson, Associate
Industrial Agents: Fred Hedberg, CCIM, SIOR, Principal | Phil Simonet, Principal | John Young, CCIM, Vice President | Joseph Schultz, Associate | Jack Buttenhoff, Associate
WHY OPERATING EXPENSES VARY FROM PROPERTY TO PROPERTY?
RELATIONSHIPS BUILT TO LAST
Paramount recently represented the Owner of 1000 West 94th Street in Bloomington. The building is approximately 5,000 square feet, with about one-third of an acre of fenced and paved outdoor storage. The client has worked with the Paramount Team for 20+ years. The relationship began with one transaction in the late 1980s, and has grown substantially since that first transaction. A mutual trust was developed during the first lease negotiation through open communication, honesty, and truly working in the client’s best interests. Over the last 20+ years, many more transactions have reinforced the trust that is the foundation of the relationship.
Too often commercial real estate services are commoditized. Excellent customer service is a lost art that few providers genuinely offer. Business owners generally have multiple projects underway at once. The ability to retain a trusted advisor to handle all real estate related tasks can free up an immense amount of time for busy decision makers. This allows them to focus on running the business. That is not to say that the business owner is uninvolved, on the contrary; constant communication between the client and the advisor is the most efficient way to build trust and create a successful conclusion to a project.
Paramount prides itself on its customer service. The team of Paramount professionals have built a brand with a reputation that Paramount has the knowledge, integrity, expertise, and communication skills to not only satisfy their clients, but go beyond to deliver extraordinary results. Paramount works hard for our clients, large and small, and seeks to obtain relationships built to last.
Written by: Joseph Schultz, East Team Associate
SUBLEASING IN TODAY’S MARKETPLACE
Subleasing in today’s market is commonplace. There are a variety of reasons why firms sublease their excess space. However, for those who intend to sublease, some caution is appropriate.
Make sure to check on the credit and payment history of the firm subleasing the space, particularly if they will pay any part of the gross rent due and payable to the Prime Landlord.
Carefully read and understand the tenant obligations under the Prime Lease. This is often an attached exhibit to the sublease document. The Subtenant’s obligation is to comply with the terms of the Prime Lease.
Make sure to receive the Prime Landlord’s formal approval, in writing. Sometimes this is as simple as a signed consent note on the signature page of the sublease document. On the other hand, the consent form can be several pages. If the Prime Landlord’s consent in the Prime Lease is something other than “reasonable,” make sure to understand what the “other” stipulations are.
If modifications are made to the space, understand the obligations in respect to the lease. Removing modifications may be a requirement upon termination of the sublease.
Make sure the life safety and exiting requirements meet local codes. Often times, a space carved from a larger space does not meet the proper exiting requirements, which may mean extra costs.https://paramountre.com/agent/phil-simonet/
For more information on subleasing space, reach out to our experts:
Phil Simonet, Principal | John Young, CCIM, Vice President | Nancy Powell, Vice President | Jeffrey Swanson, Associate | Joseph Schultz, Associate | Jack Buttenhoff, Associate
INVENTORY STORAGE? Proceed with caution.
Since 2017, days of inventory have increased for manufacturing firms nationwide, which means inventory storage has also increased. Days of Inventory in 2019 hit 59, up from 53 in 2018, and 51 in 2017. Mathematically, a decrease in the cost of sales could be causing this. COGS have actually increased slightly from 75.80% of revenue in 2017 to 75.98% in 2019. This indicates that firms have an increasing amount of inventory. Assuming this is not an over-production issue, firms are not selling as much as years prior.
This could be interpreted as a sign of economic slowdown, even before the Covid-19 storm made landfall. The increase in inventory may lead some businesses to think that they need additional space, which they may have a legitimate need for, but if the underlying reason is because of a weaker economic environment, the right course of action for the business to take might not be committing to a new long-term lease. Companies that absolutely need to move product offsite may want to explore third-party warehousing as an option. It is not as cost-effective as leasing traditional warehouse space on a per square foot basis, but allows the end-user the flexibility to change on a month-to-month time horizon.
The global health crisis has further complicated the situation. Some manufacturers now cannot keep enough stock to satisfy their customer’s needs. This may temporarily reduce the need for additional storage, even though it would be financially feasible. As with most circumstances, each should be evaluated on a case-by-case basis.
Written by: Joseph Schultz, East Team Associate
WHAT IS YOUR RENT TO REVENUE RATIO?
One financial metric that many business owners are unfamiliar with is the industry rent-to-revenue ratio (I-RRR). The math is simple; rent paid divided by total revenue from operations. Naturally, some industries will pay a higher percentage of their revenue in rent; a retail shop will surely pay a different percentage of revenue to rent compared to a small law firm.
So what is your I-RRR? With data collected across the entire nation, manufacturers, on average, paid 1.78% of their total revenue from operations toward rent. In 2017, they paid 1.87%; 2018 they paid 1.77%; and in 2019, they paid 1.69%
The amount of rent a business must pay involves many factors. Location, site access, building quality, and, most importantly, market conditions are all factors. A business in New York City will certainly pay more in rent while a business in rural Minnesota may pay less. The formula is simple, but the underlying factors can be quite complicated. Many companies believe their I-RRR should be much lower during this economic slowdown. However, the dramatic drop in rents that occurred in 2008-2009 has not happened…yet. It is possible that large-scale business closures create urgency on behalf of landlords to make low cost deals, but it is not happening now. Stay tuned for more market information as we near the end of 2021.
Source of Data: Bizminer.com
Q & A
Commercial Real Estate Questions Tenants often Ask Regarding Their Occupancy
Written by Bob Johnston | Vice President Sales & Leasing
QUESTION #1: What if the Landlord is not finished building out my space by the time I want to move in?
ANSWER: If the Landlord is actually responsible for the completed work, much depends on how the lease is written and the commencement date defined. For example, a commencement date can be tied to the substantial completion of the space, so the lease will not commence until the Landlord completes the work. Sometimes, the date is even contingent upon occupancy and the commencement of business in the space. On the other hand, there might be a specific commencement date defined. If the Landlord is late, the lease language will generally state that there is no culpability on the Landlord’s part, but the commencement date becomes the date on which the space is completed and the initial term extended from that date. In short, these issues are negotiable and dependent on each tenant’s situation.
QUESTION #2: Toward the end of each calendar year, the Landlord sends us a note informing us of the new Common Area Maintenance (CAM) & Real Estate Tax estimate for the following year. However, we never get a breakdown of the actual expenses. Is that available?
ANSWER: Most landlords will provide that information if requested. It always helps to have language in the lease that allows for a tenant’s review of the costs; and with larger tenants, audit rights are always helpful.
QUESTION #3: What do I need to do to get the tenant improvement allowance provided by the Landlord?
ANSWER: Typically, for smaller tenants with smaller budgets, all that is required is a formal letter requesting Landlord reimbursement of the allowance and proof of completion accompanied by all subcontractor lien waivers. For larger jobs, sometimes a title company gets involved and administers “construction draws” and monitors the construction progress.
QUESTION #4: Do I need to hire a disinterested third party architect to confirm the size of my space?
ANSWER: Typically not. This can be warranted in certain circumstances. Individual spaces/bays are already pre-measured by the building’s architect and floor plans are drawn based on those measurements. Therefore, the space computation is generally accurate. RU factors can vary by building, and are often much higher in smaller buildings. It helps to check the accuracy of the actual useable space and clarify the respective RU factor to calculate the rentable area (the number that determines the annual rent).
Get answers to all your commercial real estate questions.
Call (952) 854-8290
Successful Commercial Leasing=Understanding Your Rent
by Bob Johnston | Vice President Sales & Leasing
THE TERMINOLOGY OF RENT
Most commercial leases today are “net leases”, meaning that the tenant pays a “base rent” which is “net rent”, or separate from, the operating costs and real estate taxes for the property. The operating costs are then passed on to the tenant as a separate cost, equaling a total rent cost and what many then refer to as “gross rent.”
Even this varies, however, from property to property. For example, often times in retail and industrial properties, tenants pay for their use of electricity and gas as well as janitorial services. In addition, sometimes the tenant, at its expense, must contract for local trash pick-up. These separately contracted costs are not part of the ordinary operating expenses. On the other hand, office leases typically are “full service” leases. In other words, there are generally no extra charges, other than perhaps charges for extraordinary use of services such as air conditioning or cleaning, etc.
It is critical that a tenant understand the complete picture and know what the total rent will be. In addition, it is also critical that the tenant understand what expenses make up operating costs and what costs are reasonable and legitimate. It is obviously to the landlord’s advantage to get the tenant to pay as much of the total operating budget as possible. This is even more critical in mixed-use projects where landlords tend to shift maintenance costs for the residences to the office component. Thus, the office tenant contribution is actually more than what it should be. I once audited the landlord of a very large mixed-use project in Chicago and found over $100,000 wrongfully allocated to the tenant even though the lease prohibited their doing so.
WHAT SHOULD NOT BE INCLUDED IN RENT?
Here are some suggestions as to what to eliminate from the landlord’s menu. The list is obviously not exhaustive, but rather illustrative of some of the costs landlords attempt to pass on to tenants:
Leasing commissions, space planning expenses with architects/interior designers, or even attorney costs associated with a lease negotiation or existing tenant dispute
Costs associated with the construction of tenant improvements, either with new tenant relocations or existing tenant renovations and remodeling
Costs associated with the entity of landlord, particularly as it relates to partnership/ownership issues or the selling or refinancing the property
Many large landlords have affiliates or interests in affiliate companies, so it is important to ensure that the contracted vendor costs are no more than what an unrelated third party vendor might charge
Be careful about the expenses for salaries, benefits, etc. that go into “management fees.” Executive salaries, or any allocation of those salaries, should not be part of the operating costs for the building
Capital improvements are not, by accounting standards, expense items, although landlords can routinely pass on the amortized cost of the improvement as an operating expense
Make certain that in a retail environment, the tenant’s pro-rata share of operating expenses is calculated over the entire leasable area of the property rather than only on the space currently leased and occupied.
Proper due diligence and understanding of the components of a building’s operating budget are critical to a tenant’s successful occupancy, financial stability and long-term enjoyment of the space.
WEST BLOOMINGTON BUSINESS CENTER
6300 W Old Shakopee Rd, Bloomington, MN
Written by: Fred Hedberg
In 1997, Fred Hedberg, Principal of Paramount Real Estate Corporation was asked by a past client to determine the value and marketability of some excess land that was remaining after building a mini-storage facility on a site in Bloomington, Minnesota. Fred provided a valuation and marketing plan for the land. He also suggested that his client might want to consider developing an office-showroom or industrial building on the site. The market for that type of product was very strong at that time. Fred suggested to his client that if this was of interest, he would like to co-develop and own the building with his client.
Forming a Partnership-The prospect of continuing to own the land and to not pay capital gains tax on a sale was appealing to Fred’s client. It was beneficial having the opportunity to partner with a seasoned real estate professional who had a good understanding of the market and what kinds of buildings and spaces tenants were looking for at that time. They agreed to move forward on a new development together. They began to work with an architect and contractor to lay out a building on the site that would meet current market demands for space and to meet the test of time.
Developing the Property-After a review of financial projections prepared by Fred, a partnership was formed to move forward with the project. Construction drawings were completed, city approvals and financing was secured. Krause Anderson was selected to act as the general contractor for the new 80,714 SF project called West Bloomington Business Center.
Completing the Project-Paramount Real Estate Corporation was hired to lease and manage the building for the partnership. The shell building was completed in 1998 and it was fully leased and built out by the end of 1999. The building attracted well-known local and national tenants that leased the majority of the building as office space.In 1999 the building was recognized by NAIOP as a recipient of their Awards of Excellence for the Light Industrial-High Finish category. The building has performed well though the various real estate cycles that followed and has stood the test of time as different tenants with uses other than office have found it to be a desirable building and location for their businesses.
Selling the Building-After 20 years of ownership, Fred and his partner decided that it would be in their best interests to sell the building during the current business cycle for estate planning purposes and to maximize their return on the investment. Fred found a local investor that was in need of a 1031 exchange property. West Bloomington Business Center fulfilled his exchange requirement and his desire to own a well performing, high quality asset. The property was sold in August 2018 and the new owner hired Paramount Real Estate Corporation to continue to lease and manage the building.
Paramount Continues to Lease and Manage Property-Fred and his leasing and property management team are excited to be able to continue to work on this project in the future. See detailed information about the space currently available at West Bloomington Business Center.
If you would like real estate investment advice,
For firms whose growth is uncertain . . . or . . . perhaps a firm that is opening a new office or starting a business . . . subleasing space can be a sound alternative. However, just as with any real estate transaction, caution is always in order.
Get to Know The Sublessor:
First, it helps to understand why the original tenant wants to sublease. Is their business struggling? Have they lost a number of key employees? Did they overestimate their future growth? Or perhaps they are reconfiguring their space into a more collaborative environment and find they don’t need all of the space. What are their future plans? When does the prime lease expire? All of this is key since subtenants must comply with the terms of the prime lease.
Second, most sublease space is leased in an “as is” condition, meaning that the prime tenant will provide no dollars for any changes to the space. Therefore, review the language of the lease to see what restrictions might apply to any alterations. Generally, the prime landlord’s consent and approval is mandatory. Also, if you plan to make any significant changes, consult the prime landlord. Changes that actually affect the configuration or general function of the space can cause problems in re-letting the space once you move out.
Have an Real Estate Professional Review the Lease:
Lastly, ensure that the terms of the sublease document are sound and complete and that you, as the subtenant, are protected in the event of some kind of default by the sub-landlord.
If we can offer any advice or assist in any way, please feel free to contact Paramount. Proper preparation before moving forward is essential to any successful real estate transaction.
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service and solutions, call Paramount.
Have you purchased a commercial or industrial building lately? If so, then you know the Minnesota Pollution Control Agency is aggressively regulating vapors that may seep into buildings. Cracks in concrete floors, holes in the foundations, and just plain porous concrete can be conduits for harmful chemical vapors that may exist from contamination on your property or even the neighbor’s property.
Environmental consultants are recommending vapor testing for sites that are near known
groundwater and soil contamination.
If the tests are positive, a second round of testing may be completed before designing a treatment system. Typical treatments include creating negative pressure under the floor slab and venting it out the roof. This can be expensive, $1.00-$2.00 per building square foot. As you may know, when the MPCA is concerned, so are the banks. We have worked on four transactions in the last two years that required vapor treatment. It did not stop the transactions, but the process takes time, effort, and attention to detail in order to be successful.
Need real estate advice. Call Paramount.
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