Doing business successfully requires that a company bring in more revenue than what goes out in expenses. An office building lease is a major expense and a rent to office lease ratio is something that must be carefully considered in good lease planning to ensure a cost-effective lease. One important job of tenant representation services is to help businesses estimate their rent to revenue ratio so they can determine if they are paying too much for their lease. Tenant reps play a vital role in helping a company negotiate and establish the best lease, which should be dependent upon the type of business, location, and income estimates based on past performance.
What Is Rent to Revenue Ratio?
Tenant reps explain that a rent to revenue ratio is a measuring system that any business who leases office space can use to ensure they are not paying too much for that space, in comparison to their income. This calculation differs based on geographical location, industry, and the local commercial real estate market. This ratio is also known as occupancy cost ratio."By using this tool, tenant representation services can help their clients understand what they should be paying for an office space, and provide a target to meet when negotiating a new lease.
How Is Rent to Revenue Ratio Calculated?
Tenant representation services say that the rent to revenue ratio is a concept relatively easy for businesses to grasp. What it means is that a company’s lease expenses should not exceed a certain percentage of their annual revenue for the greatest cost-effectiveness. The calculation itself is performed by dividing the annual cost of business rent by the annual revenue, or estimated revenue. The resulting percentage is the rent to revenue ratio. Most commercial leasing markets have established rent to revenue benchmarks by each individual industry.
These benchmarks are used as a guide by tenant representation services to help determine how much lease their clients can comfortably afford. The recommended percentage can range from only a few percent to as high as 15 percent or more, depending on the industry; however, tenant reps ascertain that a rent to revenue ratio does not consider any other expenses, like taxes and operating expenses. Therefore, a company must be cautious of higher percentages since they must still pay all of their other expenses as well.
Notes About Rent to Revenue Expenses
Generally speaking, the lower the rent to revenue ratio, the better for the company leasing the space. Yet in certain cases, paying a higher rent to revenue ratio could be beneficial. Many things must be carefully considered, including other business and lease expenses, before determining that a higher percentage is cost-effective. Occupancy cost ratio also provides a bargaining point for some companies as well. Experienced tenant reps should be able to search for a property’s ratio history for even more bargaining power. This is also a valuable calculation in determining whether a company should invest in a particular building based on projected revenue and also whether a company's previous investment in a building is paying off or is still affordable in terms of current revenue.
Obtaining the most cost-effective lease can be challenging; however, this should always be the end goal for any business that wants to be successful at what they are doing. Expert tenant representation services can help a company determine their rent to revenue ratio and whether their current, or another prospective lease, is right for them. Tenant reps use rent to revenue ratios and other methods of financially analyzing a lease to ensure their clients get the best lease agreement possible!