Renting commercial real estate can be a complicated endeavor for a company trying to find the right space at the right price, with all the necessary lease inclusions. The question is: what exactly is the right price for a particular property? While commercial real estate brokers work within the current leasing trends in local markets, estimating a rent to revenue ratio is another important step in determining whether a property is the right one for a business.
Useful for budgeting, as well as commercial lease negotiations, a rent to revenue ratio is something a company and their commercial real estate agents should estimate ahead of time, so they know whether a specific leasing arrangement is likely to be the best one, at least financially.
What is Rent to Revenue Ratio?
One way a company can determine whether a certain office space for lease is affordable is to configure what the building’s rent to revenue ratio, or occupancy cost ratio, would be. This figure is determined by dividing the annual base rent of a property, by a company’s forecasted yearly revenue. Occupancy costs used to be estimated based on seven main calculations:
Monthly and yearly rent
Total lease amount
Effective rental rate for entire lease term
Cost per square foot
Occupancy cost per person
Square feet per person.
Determining the rent to revenue ratio has proven to be a more accurate predictor of actual occupancy cost, and whether or not leasing a certain office space makes good financial sense for a company.
What Is A Good Rent to Revenue Ratio?
Determining a good rent to revenue ration depends on the type of business. Typical rent to revenue ratios vary from as low as two percent to as high as twenty percent, although most fall in the ten to fifteen percent range. A retail business wants a lower rent to revenue ratio since they already have to contend with the cost of higher overhead in the form of sales inventory. A professional services business commonly leases near fifteen percent; however, this is due to lower overhead costs. Generally speaking, each commercial realty market has benchmark rent to revenue ratios for various types of local businesses. Therefore, it is a good idea to get this information from commercial real estate brokers while considering potential lease property options.
Why Is A Rent to Revenue Ratio So Important?
The main reasons why rent to revenue ratio is important to a business leasing commercial space is that it provides a way to measure one property’s market worth against another as well as a way to decide if a space is affordable based on projected revenue. This number is also a critical tool in determining whether a higher rent to revenue ratio might be prudent concerning a property that has more to offer, particularly if it can be foreseen this cost may be offset by positively affecting revenue. Finally, regular calculation of rent to revenue ratio during occupancy provides a way to gauge if revenue numbers are performing as expected, and if the cost of that commercial space is is making a positive or negative impact.
Based on the above, it is possible to understand how rent to revenue ratio can be a critical consideration for a company. It is something that should be discussed with commercial real estate brokers when searching for the perfect office or commercial space. Estimations of this figure are important to budget for a lease and for take a good look at a company’s actual financial picture as well as the impact of a certain property on that picture. A rent to revenue ratio can also become a valuable tool in commercial lease negotiations. To ensure the best leasing decisions are made, a company should research their past and current ratios, and compare such numbers to projected rent to revenue ratios of any new property in which there is an interest!