Tips To Optimize Your Commercial Real Estate (CRE) Portfolio

March 1, 2021 Don Catalano Don Catalano

Rent isn't just rent. When you lease a commercial space, your rent pays for your commercial space, but you also make two additional payments -- even if it's all in the same check. One way or another, you also pay common area charges, which are the cost of running the building. In addition, you also pay a load factor, which is a way for the landlord to collect rent for the parts of the building that everyone shares. The hallway outside your suite? Yup. You're paying for it!

 

Extra Charges in Commercial Real Estate

It isn't easy -- or cheap -- to run a building. When an investor purchases a piece of commercial real estate, they stroke a huge check for their down payment. Then, they usually take out a multi-million dollar loan for which they pay thousands or millions of dollars a year in interest. Next, they pay all of the building's operating expenses, including everything from property taxes to snow removal to making sure the elevators don't break. In exchange for all of that expense and trouble, they collect your rent, and hope to make a little bit of extra money. For large office buildings in major cities in the US in 2020, it's not uncommon for owners to earn returns in the mid-single digits when they buy the building -- 4 to 6 percent. That's it.

 

Owners have two ways of maximizing their returns. One is to collect rent for as much of the building as possible. If you lease a 40 by 80 square foot space, you pay rent on the 3,200 square feet that you occupy. But how do you get to that space? You get there by walking through a lobby, riding an elevator, then walking down the hall on your floor.  Since you use those spaces, you pay rent for them through something called a "load factor."

 

Consider those hallways for another minute. They're brightly lit. And the floors are vacuumed. When you go to the bathroom that you share with the other tenants on your floor, the soap dispenser has soap and the stalls have bathroom tissue.  Downstairs, there's a security guard in the lobby that greets you in the morning.  All of those building services in the "common area" cost money. And if you have anything other than a full service or gross lease, you're paying directly for those costs as common area charges.  This way, you get the services you need, and the owner gets to transfer some of those costs back to you since you're the one that benefits from them.

 

What to Know About Load Factor

 

Three Ways to Measure Space

Most buildings have three different sizes -- their gross square footage, their rentable square footage, and their usable square footage. To understand them, let's measure a sample building.  For example, let's take the Bank of Somewhere Plaza in a mid-sized downtown. It's a 30 story building that is 100 feet wide and 170 feet long. This gives it a 17,000 square foot floor-plate. For simplicity, we will leave out some of the most complicated details (for those, look to the standards published by BOMA -- Building Owners and Managers Association -- International), and we will only look at one floor of the building. Let's go!

 

Multiplying the two outside dimensions gives us the gross square footage. So, 100 times 170 equals 17,000 gross square feet. This is the largest possible measurement for the floor.

 

Most buildings have holes in the floor -- technically referred to as vertical penetrations. When you have an elevator shaft, a pipe chase or a stairwell, there isn't a floor there, and that area gets subtracted from the gross area to find the rentable square footage. It's entirely reasonable to assume that there are 400 square feet of vertical penetrations on a floor in this building, so we subtract 400 from 17,000 to get 16,400 rentable square feet.  This is the amount on which your rent gets calculated.

 

If you leased the entire floor, your usable square footage would be the entire floor, but let's assume that you only lease a portion of the floor. Specifically, let's assume that you take a 40-foot wide by 90-foot long chunk.  40 times 90 gives you a 3,600 usable square foot space. That's your private suite, but it isn't what you pay rent on. To calculate that, we need to learn more about your floor.

 

Your floor has three offices -- your 40-by-90-foot office, a 45-by-160-foot office on the other side, and another 40-by-70-foot office on your side. When you add their areas up, you get a total of 13,600 usable square feet on your floor. But, the floor's rentable area is 16,400 square feet. Your rentable area is your usable area plus your pro-rata share of the extra space. To find your pro-rata share, divide the total usable area of the floor -- 13,600 -- into your usable square footage -- 3,600. 3600 divided by 13,600 equals .2647. If we multiply the 2,800 square feet of common area by .2647, we find that you pay rent on 741 square feet of common area. This makes your total rentable area 4,341 square feet -- 3600 square feet of usable area in your actual suite and 741 square feet of common area hallways, bathrooms, elevator lobbies, and whatnot.

 

Rentable Usable and Load Factor

The load factor is a way to convert between rentable and usable square footage. To find a building's load factor, divide the usable square footage into the rentable square footage, then subtract one. For this building, you would divide 13,600 into 16,400 to get 1.20588. Then, if you subtract one, you will find a load factor of 0.20588. This means that for every square foot of usable space, you will take another 0.20588 square feet of common area.  Frequently, this gets expressed as a percentage -- so you would describe this building as having a 20.6 percent load factor.

 

Managing the Load Factor

Load factors are usually fixed by a combination of the building's physical layout and the owner's measurement system.  If they follow the X measurement standard and the hallways are Y feet wide, your load factor is going to be Z.  However, you can go beyond simple math and still manage your load factor by using these (and other!) ideas.

  1. Look for a building with a lower load factor. Usually, the less amenity space, the lower the load, and the more usable space you get.

  2. Double-check measurements. Landlords don't always get their measurements exactly right, and they're more likely to make an error in their favor than yours.  If you're leasing a lot of space, having an architect take a look might save you money in the long run.

  3. Negotiate hard. There might be room for negotiating how load factors get measured. Alternately, if you're on a floor with no amenities and you end up paying for lavish amenities elsewhere through your load factor, it's reasonable to ask for a small rent reduction.

  4. Take the whole floor. While this won't change the load factor, it might turn the hallways and common areas into usable spaces. For example, your elevator lobby can turn into your reception area and you can place office machines in the hallways.

 

Example Scenario (The Best $100,368 You'll Ever Spend)

Imagine that the building we are discussing here has net rents of $30 per square foot and CAMs of $18. Under this scenario, you would pay

 

  • $108,000 of net rent on your usable space (30 times 3600)

  • $64,800 of CAMs on your usable space (18 times 3600)

  • $22,230 of net rent on your common area (30 times 741)

  • $13,338 of CAMs on your common area (18 times 741)

In other words, your $108,000 annual rent bill turns into $208,368 of total occupancy cost -- almost double what you might have thought. Believe it or not, this is actually a great deal. That extra $100,368 of expense gets you full access to things that you need, but that you don't have to completely pay for. You absolutely have to have a bathroom. And lights in the hallway. And a garbage room somewhere in the building. And it's nice to have that training center down on the third floor for your monthly meetings. But you share the costs of all of those features with your co-tenants. You get them when you need them. And everyone else helps pay the bills for them.

 

Conclusion

There is a lot more to understanding your office space than just multiplying the dimensions of your suite by your rent rate. While CAM charges, load factors and common areas might seem like necessary evils, they also benefit you and make your tenancy experience more convenient, more pleasant, and more affordable.

 

We can help you optimize your commercial real estate portfolio. Reach out to us today to learn more!

 

Here are a few other articles we know you'll enjoy:

What to Know About Rent Escalation Clauses

6 Commercial Real Estate Trends Going into 

Artificial Intelligence in Real Estate: The Future of CRE?

 

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