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
WHAT IS YOUR RENT TO REVENUE RATIO?
Successful Commercial Leasing = Understanding Your Rent
by Bob Johnston | Vice President Sales & Leasing
THE TERMINOLOGY OF RENT
Successful commercial leasing is all about understanding your rent. Most commercial leasing 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. Also, it is critical that the tenant understand what expenses make up operating costs. Then understand 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. Mixed use is 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. I 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.