July 24, 2007
Mike Byrum
Mainsail Development Group
In June’s issue of Insight Business Update, we discussed the selection of a space in which to locate your business. We talked about judging spaces based on the experience that space would allow you to provide to your customer, your employees and you. In last month’s article, we contemplated how much space we actually need, and what steps and challenges we could expect in preparing our space to open for business.
This month we will discuss the occupancy costs we can expect to encounter once we occupy our space and are open for business.
New business owners many times mistakenly view the base rent outlined in their lease as their sole occupancy cost, overlooking the myriad of other costs involved in operating a business. More accurately, occupancy costs are the broad name for all expenses associated with your space. It is essential to the success of your business that you are familiar with and account for this range of expenses. They can be broken into the areas of base rent, additional rent and “add-ons.”
It is helpful to understand a little more about commercial leases before addressing base rent and additional rent. There are several different types of commercial leases. They range from a gross lease, where the tenant’s occupancy costs remain constant throughout the year regardless of what it costs the landlord to operate and maintain the property, to triple net leases, where upkeep expenses are passed through to the tenant, making the tenant responsible for any fluctuations in those costs. Gross leases are primarily found in office markets, where triple net leases are found in retail markets. Gross leases contain no provision for additional rent, whereas additional rent is the distinctive feature of a triple net lease. Because the majority of properties in east Orlando use triple net leases, and therefore require additional rent provisions, we will focus on them in our discussion here.
Base rent typically stays constant for the first 12 months of your lease, but will normally escalate by some predetermined amount every 12 months over the life of the lease, beginning with the 13th month of the lease term. For example, if your base rent on your 1,200 square foot space was $25, you would pay $30,000 annually (1,200 x $25 = $30,000) or $2,500 monthly ($30,000 / 12 months = $2,500) for the first year of your lease term. However, if your base rent were scheduled to escalate by three percent for the second year of your lease you would pay $30,900 annually ($30,000 x 3% = $900 + $30,000 = $30,900) or $2,575 monthly ($30,900 / 12 months = $2,575) during that second year of occupancy.
Additional rent, or pass-thru expenses, are the expenses associated with the property in which your space is located that are passed on to the tenants and split among them on a pro-rata basis based on the amount of square footage each one occupies. As mentioned earlier, these expenses can fluctuate, potentially resulting in increased additional rent payments. A savvy business owner will incorporate a contingency item in their budget for such possible fluctuations. Some examples of pass-thru expenses include common area maintenance (i.e. garbage service, landscaping, etc.), real estate taxes and property insurance.
“Add-on” expenses are the costs incurred by the actual operation and maintenance of your business. These add-on’s consist of building supplied services (i.e. parking, after hours air-conditioning, utilities, etc.) and additional services, including plant service, pest control, janitorial services, coffee, Muzak, furniture rental, art rental, HVAC maintenance, general liability insurance, etc. This blanket of services can cost in excess of $1 per square foot annually. Although these costs are significant, many business owners overlook them, as they are not as easily identified as base rent.
By accounting for all of your ongoing costs associated with your location, you give your business a significantly better chance of being successful and profitable. This knowledge, along with our discussions in previous issues, affords you valuable insight you will need in your effort to make sound, informed real estate decisions when opening your business.
