In this article, you’ll discover:

• The impact of rent abatement and rent escalation clauses on long-term expenses.
• How operating expenses can significantly influence your total occupancy cost.
• Importance of Tenant Improvement Allowances (TIA) and strategies for minimizing renovation-related costs.
• How a True Tenant Rep™ can negotiate better lease terms and reduce costs.

When you’re in the market for commercial space, it’s crucial to not just focus on the base rent, but to consider the complete financial picture.

Calculating the total occupancy cost involves examining far more than just the rent you pay to your landlord. It encompasses the total cost of operating a commercial property. Managing these occupancy costs efficiently can significantly impact your bottom line and the success of your business.

In this article, we’ll delve into the intricacies of these costs, breaking down what goes into determining the total cost and how savvy tenants can navigate the world of commercial property expenses to secure a favorable lease that suits their business needs and financial objectives.

Base Rent

Base rent is often the most obvious aspect of your monthly occupancy costs when leasing commercial or office space. It’s the foundation of your lease agreement, typically calculated on a per square foot basis.

It can vary widely depending on how competitive the market is, the building’s condition, location, negotiation outcomes with your property owner, the lease term’s length, and whether or not you’re utilizing a True Tenant Rep™ to help you with the process.

In essence, your base rent forms the core of your occupancy expenses and, not coincidentally, offers the most substantial opportunity for negotiation. Efficiently managing occupancy costs starts here, as getting favorable base rent terms can make a significant impact on your overall financial well-being as a tenant.

Rent Abatement and Rent Escalation

In negotiating your rent costs, your landlord may offer you a period of rent abatement as a concession.

Rent abatement is a period in which you occupy the space but do not pay rent. This period of free rent can provide some relief to your year one budget, but influence your total occupancy costs in other ways.

For example, to achieve a higher base rent than perhaps the market is willing to pay, landlords will often offer the incentive of free rent (aka rent abatement) for the negotiated period of time. Typically, landlords will want to tack on the amount of free rent months onto the back end of the lease so as to achieve the original lease term they desired.

For instance, if the original lease term was 10 years (120 months) and you were able to negotiate 1 years free rent, then the landlord will most probably desire to have a lease term of 132 months. So, you still get the first years abated, but the landlord receives 10 full years of payments.

That leads us to one of other most significant elements of a lease’s overall cost: the rent escalation.

Escalations can eventually become the single most determinate factor of the tenant’s occupancy cost because they are compounding and therefore increase on a previously raised number. This increases the danger of getting the wrong type of escalation into your lease. Read more about the dangers of a bad rent escalation clause. 

Here are the four type of rent escalations:

• Rent Bumps
• Percentage Increases 
• CPI Escalations
• Hybrid – Mixture of Types

Operating Expenses

Who can forget the most critical element of calculating occupancy costs outside of rent?

Operating expenses (OpEx) constitutes one of the paramount components of your office lease, and understanding them is pivotal to successful negotiations. They encompass the entire spectrum of costs necessary for the efficient operation of a building. Within this broad category, you’ll typically encounter the utilities cost, common area electric bills, office cleaning services, water supply, trash removal, security provisions, landscaping maintenance, property taxes, and common area maintenance costs.

While OpEx might start as a relatively small percentage of your lease, it’s imperative to recognize that over the term of your lease, they can accumulate to represent a substantial portion of your overall occupancy costs, sometimes reaching as high as 40%.

Your engagement with these operating costs will greatly depend on the type of lease you sign. In the case of office leases, especially for full-service or gross leases, you generally pay a base rent to the which encompasses all additional charges. Your property owner then allocates these funds to cover the various costs related to OpEx and engage vendors to ensure the building’s smooth operation.

On the other hand, in a triple net lease, which are more commonly associated with warehouse spaces or build-to-suit properties, differ in structure. Tenants typically pay a lower initial base rent directly to the landlord because they are responsible for covering OpEx and other costs directly. Essentially, the total costs are the same across the lease types; they are just packaged differently. Note the sample below to see how charges get split up depending on the type of lease you have. 

The other point to mention is that your landlord will likely agree to cover a portion of the OpEx, while passing on any expenses beyond this threshold passed on to you, the tenant. Their portion, known as the expense stop, is critical in negotiations. 

Your property owner will maintain the original expense stop, whether prices remain the same or go up. It is also not likely that you will be able to negotiate for readjustments to the expense stop so the importance of an accurate expense stop is heightened. By doing so, they are protecting themselves from inflation while leaving you vulnerable to it. In this case, your operating expenses are likely to grow over the term of your lease. That is why it is so critical to apply due-diligence in regards to OpEx in the negotiating stage and ensure that the expense stop isn’t too low. 

Costs Related to Renovation

When it comes to transforming a leased property into a suitable workspace for your company, renovations are often necessary. Landlords typically provide a Tenant Improvement Allowance (TIA) to cover some of these expenses. However, any renovation costs that go beyond this allowance will need to be funded from your budget.

It’s crucial to have a clear understanding of where your TIA coverage begins. If you’re leasing a first-generation space, it may require substantial work to make it functional for your needs. You want to avoid the situation where you end up covering the basic construction costs for someone else’s building.

As the tenant, it’s your responsibility to determine the starting point of the property condition from which you are accountable for buildout costs. Failing to do so could result in you overpaying to bring the landlord’s property into a suitable working order. So to confront this, make certain that your TIA begins at the warm, vanilla shell condition. 

This is especially important in a leasing environment where commercial real estate owners are offering higher TIAs than ever to lure tenants in to their buildings. Doing so is forcing them to reduce their profit margins (when most are already on rocky ground). Putting your Tenant Improvement Allowance in an escrow account is a smart way to ensure you don’t lose any money in this new environment, driving up your occupancy costs even further.

How to Find the Best Office

Obviously, there’s a lot to keep track of when it comes to minimizing the cost of your occupancy, and we’ve only explored the tip of the iceberg today. That’s why a True Tenant Rep™ is essential when negotiating the costs of a commercial lease. They can provide you with valuable market insights, negotiate on your behalf, and provide guidance throughout the entire process. With a True Tenant Rep™ on your side, you can be confident that you are getting the best possible lease terms and minimizing your occupancy costs.

Working with a True Tenant Rep™ can help you negotiate lower rent, but not just lower rent, operating expenses and escalation rates too. They are skilled at negotiating with landlords to commence the TIA from a tenant-favored condition. This way, you’ll only need to allocate your budget for enhancements that go beyond the standard building specifications. 

Watch our free course to learn how to find the best office space for your company’s needs, at the best price!