You’ve made the decision to ‘get out of the house’ and you’ve done your homework on what it will cost, and how it will change your operations and projected revenue and earnings… Almost. You won’t know your total fixed and variable costs until you know what it will cost to occupy any given space or building. we will look at these occupancy costs now.
When renting or owning your business location, the total ‘cost to occupy’ includes not only rent, but also utilities, insurance, maintenance, and operating expenses. The expenses above and beyond base rent can be substantial; in some cases as much as 50% more than your rent.
Rent can be one of your largest fixed costs and the amount of revenue it eats up can mean the difference between thriving, surviving, and disappearing. Every business can easily calculate their rent-to-revenue ratio (RR) by dividing their annual rent expense by annual revenue. Perhaps the critical consideration is that every industry has a standard RR derived from successful business practices within that industry. Why is this important? For example’s sake let’s say your industry RR is 9% and even though your RR is 12%, you’ve remained profitable. Will you still be able to compete if something happens in your market or industry that shrinks revenue or margins? Maybe; maybe not. It’s undeniable however that a 3% revenue savings would be a huge contribution toward earnings.
Rent-to=Revenue Ratio – Every industry has a different RR and they range from 1.5% to 14%. If you don’t know what the RR in your industry is, you may be giving the competition an edge simply by renting too much space or paying more than you should. If your industry RR is 6% and a competitor (also a million dollar business) is at 6% RR paying $5,000/mo rent ($1m x 6% /12 mo) and your RR is 7.5% it may be manageable but you’re giving up $15,000 a year in earnings. $15,000 in operating capital. $15,000 in pricing and margin latitude.
So how do you select the right location? There are many considerations; far too many to address here but I’ll hit the high points. Most importantly, hire a tenant representative to locate and vet spaces, arrange inspections, educate you on the process, and negotiate on your behalf. 99 times out of 100 it will cost you ZERO. They’ll be paid by the Landlord. At the very least, spend the time and effort to be informed about your leasing market.
There are different types of rate structures in commercial leasing depending on the property type and in some cases, Landlord preference. Triple Net leases, Net Leases, Gross, Industrial Gross, and Modified Gross leases, Full Service leases, and Percentage leases make up the majority of leases in use. Triple Net and Percentage leases are more common in retail space, Full Service or Gross leases in the office market, and modified or Industrial Gross leases in the Industrial market. Nearly all of these lease types has additional expenses that come with them. Triple Net leases only cover the building and the tenant is billed for their pro rata share of property taxes, property insurance, and operating expenses including management fees. This expense can be as much as $1.00/sf/mo in many markets. Full Service leases generally cover everything including utilities and janitorial service.
There may be a space with a Triple Net rate of $1.00/sf and a Modified Gross lease space offered at $1.10/sf. Until you know what the additional expense of each is, you have no way of comparing the costs to occupy. Have your broker calculate the total cost to occupy spaces that you are interested in to ensure you are making sound decisions.
Lastly, economic events of the past 4 years have brought the price of commercial property down quite a bit in some markets and product types. There is still an elevated level of commercial properties for sale and contrary to what you may be reading in the news, there is mortgage money available for the small business owner. One of the most attractive programs is the SBA 504 guaranteed loan program. Generally, a solid operator with 3 or more years of business performance can apply for a 90% LTV package (50% first, 40% second). It is not uncommon to be able to own a building at or below the cost to rent but again, you must calculate the TOTAL cost to occupy any space before making a decision.
Consult your broker (me) and make them do the professional tasks of securing you the best space, at the lowest cost, under the most favorable terms. Your time is better spent at YOUR business.