Getting a Handle on Total Cost of Occupancy & Other Lease Obligations.
And just like that, it is a tenant’s market. For the last decade, Landlords have had a great run. Those benefits to Landlords included; low vacancies, steady rate increases, and an abundance of new building tech for capital improvements. Well-qualified tenants were signing longer leases, and smaller occupants were given tenant improvement packages requiring little effort (but were still subject to PM fees). It’s our position that in just under two months’ time, the pendulum has swung back in favor of the tenant.
With all the fodder from furniture groups hoping companies will fully reconfigure, to broker stories alluding to phantom clients looking to double their size to accommodate social distancing…just stop. This doesn’t make sense. This is the time to gain a sound, data-driven understanding of the total cost of occupancy. This audit process should allow you to accurately understand OpEx down into a single office, a region, nationally, or globally with the click of a button. Workplace Solutions Groups and CFO’s should be able to track every lease dollar (Rate, CAM, CAP, Taxes, Insurance, Utilities) as well as every Tenant Improvement Dollar (Construction, FF&E, Move Fees, IT Expenses) across the enterprise. After all, occupancy is generally accepted as a company’s second highest expense behind payroll and benefits. With work from home programs proving to be viable, it’s becoming the obligation of the execs to understand the cost / benefit of the office. It starts with centralizing those costs and auditing the current expenses across the portfolio. This is the time to build standards into lease documents, furnishings, construction, and IT. Right now.
So much efficiency is lost or gained right here. A proper program of how people work is important but understanding the building’s loss factor might be even more beneficial. Loss factor is the difference between the Rentable Square Footage (amount of space you pay for) and the Useable Square Footage (amount of space you actually occupy). For the Landlord, this will determine the tenant’s financial contribution to Common Area Maintenance. We’ve seen buildings’ lease space with 25% loss factors, leaving tenants to foot the bill for lobby space, additional training rooms, and unnecessary amenities throughout the building. Always ask the landlord’s broker about the loss factor while on tour. The building should be able to give you a certified Building Owners and Managers Association (BOMA) statement. An acceptable number should be at or below 15%. Choosing a space upon geography, or because the local team knows the property manager is long gone. Data wins.
There are several types of commercial leases but for purposes of illustration here, we will look at Full Service (Gross) and Triple Net (NNN). A Full Service/ Gross Lease requires a tenant to pay a base rate and the landlord pays all associated expenses (taxes, insurance, utilities, and common area maintenance) while a Triple Net requires tenants to pay rent, as well as the associated taxes, insurance and CAM plus their individual utilities. Gross leases are convenient, but exclude tenant leverage to renegotiate maintenance contracts or have clear visibility into actual utility usage. Triple Net leases generally require tenants to carry their own insurance policy as well as manage multiple utilities and vendors. With so many variables at play here, the take away is the rental rate. Buildings are at least partially valued by Gross Rent Multiplier (GRM) which puts building owners in a position to preserve their rental rate. Years ago, rental rates were the simplest term on which to base a negotiation. Now, the negotiation has to dig much deeper into incentives (tenant improvement allocations) and / or term. In general, don’t expect the negotiated rental rate to move much from the published rate.
Each building is different, yet Orion strives for cohesion across our tenant’s portfolio. No two buildings cost the same to run. Some landlords thrive by keeping a watchful eye on spending while others prefer the higher priced vendors because they demand perfection. Operating expenses within a commercial lease leave a lot open to interpretation, and therefore present challenges and risk to the tenant. With so many vendors supporting a commercial building, it is important to request a list of qualified building expenses during the proposal phase of site selection. Rather than a gross number, it’s best to request a breakdown of expenses so we can determine the value of that space independently. Regardless of whether or not a building will align with a tenant’s budget, always negotiate for an expense stop (either by percentage or dollar amount) across the term of the lease and get a solid understanding of how capital improvement projects are calculated (or omitted) from operating expenses.
Alterations and Restorations.
Most tenants want to do something to their space to make it their own. At Orion Growth, our Spacemakers create repeatable construction and Furniture Fixture & Equipment (FF&E) standards for our portfolio clients. By applying these standards, our stakeholders have predictability around cost, time to market, and the overall feel for the planned environment. Additionally, these standards are used during the RFP process to get contractor pricing and determine the value of the incentives. The landlord can determine whether they would like to turnkey the space, or simply make it an allowance deal. Either way, the clauses around construction and restoration need to be carefully considered. Savvy landlords have found profits in controlling tenant alterations. Maintaining the flexibility to accept a turnkey deal or a TI deal keeps the advantage in the tenant’s court. Having company standards and a qualified build team is key to keeping a watchful eye on spending (as well as future warranty & maintenance).
Today’s commercial leases have so many clauses. As we have recently seen with Covid-19, Force Majeure has become a hot button topic and post 9/11 NYC had affected tenant relocation challenges. Truth is, we never see these things coming, but there’s always a way to help mitigate risk while maintaining standard operating procedures. If a landlord is requiring a 7-year lease, council might advise to negotiate an opt-out value after 60 months. Sublease provisions should be thought through and standardized across the portfolio. All of this requires conceptual ‘what-if’ planning and a cohesive set of terms that should be compiled before site-selection tours begin. These scenarios should be played out across Finance, HR, Legal, IT and Operations so a consistent contract across the portfolio exists. We can’t control events, but we can control how those events would affect our tenancy and our employees.
Some of this may be elementary while some may be enlightening. Truth is, the Commercial Real Estate market is still very siloed. Brokers want a deal done. Contractors want a clearly defined Scope of Work. Furniture vendors want a purchase order. Moving companies want solid dates. The siloed approach can be effective if you’re a single or double location tenant and very involved with the process or simply don’t see the value in audit recovery across the breadth of occupancy expenses. If you’re a portfolio client who has multiple offices across the nation or across the globe, standards are your best friend. Those standards start with lease language and finish with ribbon cuttings. Any way you slice it, the expense data should be centralized, predictable, and accurate. Expense justification should be on the forefront of everyone’s mind these days – that is if the organization is considering cost avoidance and audit recovery during these uncertain times.
Chris Moeller is the Owner and Managing Director of Orion Growth, a division of Gaia Ventures. Orion Growth is restoring the human connection by fundamentally changing the way workspace is delivered. For more information on Orion Growth, please visit www.oriongrowth.com
* Image by Carlos Muza from Unsplash