When negotiating & leasing office space you want to make sure you make the best financial decision possible. To make informed, quality decisions you must evaluate the economics of each property using a process of financial analysis that organizes and interprets data using a variety of procedures, tools and principles. This requires more than simply plugging numbers into a software program. Instead, it requires extensive experience in commercial real estate and formal financial training.
Office Lease Evaluation
The decision to relocate a business or to renew an existing lease requires a careful evaluation of the cost of each in the current marketplace. To do this, one must properly identify and estimate the costs associated with each option. These “occupancy costs” vary widely among facilities. Thus, it is critical to only compare similar facilities. In other words, compare “apples to apples”. This type of analysis can help you identify the hidden costs of a lease which can drive up the cost after occupancy. Commercial leases have a very complex financial structure which can result in a true cost that is much higher than the original lease price. Here are some of the most common costs associated with a commercial business lease:
- Base rent (fixed or escalated)
- Operating expenses and operating expense increases
- Caps for operating expense escalations
- Abated or reduced rent for certain periods
- Landlord loans for building improvements, IT cabling, architectural fees, lease commissions moving expenses and existing lease obligations
- Parking fees
- Lease options including renewal, cancellation, expansion and contraction
- Electrical capacity and H.V.A.C. charges
- Add on charges such as rentable vs. usable square footage
- Government regulation compliance costs (ADA )
- Construction management fees
- Interest fees for above standard building improvements
Evaluating Office Space Occupancy Costs
After identifying all of the costs involved with an office lease, one must calculate both the annual lease cost as well as the total cost of the lease over its lifetime. The projected annual cash flow is then discounted at a suitable discount rate (aka cost of capital) to account for the time value of money, which is called the net present value. This net present value is, in essence, the true cost of the deal.
Discounting the lease cash flows allows you to put each alternative on the same level so you can compare each “apples to apples”. Because office buildings have different common area factors (aka add on factor) and some spaces are more efficient than others you want to be able to compare the absolute and present values of each alternative. You do this by accounting for the differences in usable square feet (what you actually occupy) and rentable square feet (what you pay rent on) for each office space.
Software makes this type of analysis simple, although it is critical to understand the underlying fundamentals of the calculations. Some of the most common financial analysis software include REI Wise, Lease Matrix, CoStar Lease Analysis and ProCalc.
Financial Analysis and the Office Space Negotiation Process
Great lease deals are both found and negotiated. The office lease negotiation requires understanding the true cost of the lease from the tenant’s perspective and the Landlord’s effective rental rate (expressed on a square foot bases). The Landlord’s effective rental rate is basically their net profit on the lease before they pay the buildings debt (mortgage) payments. Performing this calculation allows you to understand the landlord’s bottom line.
At the end of the day no two lease transactions are the same. You can’t assume your neighbors deal is better than yours simply because they have a lower base rental rate than yours. There are many other concessions that you may have that your neighbor does not.
When negotiating office leases our goal is to create a win-win situation whereby we don’t leave any money on the table however the landlord is able to achieve their ideal yield.