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Costs of Leasing Office Space

What other expenses are involved in leasing office space?

There are a lot of things to consider when you are calculating how much your rent and other office occupancy expenses will actually cost. Some of the items you may encounter are discussed below:

What is base rent?

Base rent is the amount of money you pay to lease your space and it is specified in your lease. It is generally stated as a whole dollar amount (e.g. $30,000 per annum) or as dollars per square foot (e.g. 1,500 square feet at a rate of $20.00 per square foot). The lease will also state if this is a Net Rent or a Gross Rent. Gross Rent generally includes all the operating expenses required to run the overall building on a day to day basis and includes such things as trash removal, janitorial services and such. You will also probably pay additional expense or additional rent which represents items such as your personal electric use (things you actually plug into the walls within your space), AKA "tenant electric". Net rent excludes all the building operating expenses and you will be billed an additional amount monthly. This is usually based on your proportionate share of the total building operating expenses. (See: The Rubber Ruler) But these definitions of "net" and "gross" vary widely, so you need to ask about what is specifically included or excluded from the rent you are quoted.

What are operating expenses?

Operating expenses are all those expenses that are generally required to keep an office building running. Operating expenses are usually divided into two components: 1) Real Estate Taxes and 2) Operating Expenses.

Taxes are the local real estate taxes, which are based on the assessed value of the building and the land on which it is situated. In some communities these taxes can include additional taxes such as school taxes, special assessments for sewer hook up and use, etc.
Operating expenses are the variable expenses that are necessary to operate the property on a day to day basis, such as: trash removal, snow removal, insurance, heat, air conditioning, cleaning, building repairs and maintenance, electric and lighting in the building's common areas (e.g. lobbies), and security systems and/or guards, etc.
These items collectively are known as the operating expenses. If you have a gross lease they are included in the rent, if you have a net lease, they are excluded from the rent, and must be paid separately and are generally referred to as "Additional Rent".

How does rent increase during my lease term?

When you sign your lease, you should have an absolute idea of how much it will cost during the first year of your occupancy and a basic idea of how much your rent is going to escalate over the term of your lease.

Rent escalations are usually divided into three categories:

Fixed Rent or Base Rent increases
Increases in Additional Rent,
Escalations in operating expense and taxes.
Fixed Rent or Base Rent increases are generally stated precisely in the lease. For instance your lease would say something like:

"The Base Rent shall be $30,000 for the first Lease Year, $31,500 for the Second Lease Year and $33,000 for the Third Lease Year." Or base rent increases can be calculated by formula. "The base rent shall increase by 3% per annum".

Additional Rent and any increases in additional rent are usually stated as a formula based on your proportionate share of the entire office building. For example, if a building is 100,000 square feet and you occupy 1,500 square feet, your proportionate share is 1.5%. That means you will pay 1.5% of the total operating and tax bill for the building as additional rent. The language in your lease will read something like this:

"Tenant's base rent shall be $14.00 per square foot, net of all expenses. Tenant shall pay on demand its pro-rata share of all operating expenses and taxes for the property as Additional Rent".

If you have a net lease the owner will total all the expenses and send you a bill for your proportionate share. Generally the owner estimates what the total expenses will be for the entire year in advance, divides it by 12 months to average it and bills you 1/12th of your proportionate share of the total building expenses as Additional Rent, which is added to your rent each month. At the end of the year, the Landlord will review the expenses for the year and either sends you an additional bill if he/she underestimated or sometimes a refund if the expenses were over-estimated.

Example:

A 100,000 square foot building paid Real Estate Taxes of $3.00 per square foot last year, or $300,000 per annum; operating expenses for the building were $7.00 per square foot, or $700,000. Therefore, the total Operating Expense and Real Estate Tax bill for the prior year was $1,000,000. You occupy 1,500 square feet or 1.5% of the building. Consequently, your proportionate share is $15,000 for the year. ($1,000,000 X 1.5%) If you have a net rent, your monthly Additional Rent will be $1,250.00.

Escalations in Operating Expenses and Taxes are calculated as increases that occur in these categories after you have occupied the building for a year. If you have a Gross Lease, the cost for the operating expenses and taxes are included in the rent during the first year of your occupancy; this is also known as the "Base Year". As the buildings expenses escalate in subsequent years, you will pay your proportionate share of the increases over the Base Year, or initial year of your lease. For instance, if the operating and tax bill for the entire building increases to $1,200,000 in the second year of your lease and it was $1,000,000 during the first year of your lease (the Base Year), your Additional Rent will be $3,000 or an increase of $250 per month. ($200,000 increase over the base year X 1.5% divided by 12 months = $250.00).

When you are selecting your office space, you should ask for a breakdown of the operating expenses and taxes so you can estimate what your rent increases will be during the term of your lease. In general, you can expect Operating Expenses and Taxes to follow the consumer price index. If you budget for increase in expenses of 4% per year on average your budget will probably be safe. However, you should be careful in years that a town in going through a reassessment; this could cause a dramatic increase in taxes. Ask when the next assessment is scheduled and plan your budget accordingly.

Hint: : In general, small tenants should try to select a gross lease, AKA a "full service" lease and make sure you understand what services are included in the rent. A full service lease should provide for everything except the cost of the electric you use in your space. It should include cleaning of your office space on a nightly basis, trash removal, snow removal and many other things that are generally specified in the lease or an exhibit to the lease such as "Cleaning Specifications". Make sure you understand the services you need to run your office and understand what is included or excluded from the services your landlord will provide

Net leases generally place the burden of handling most vendors and bills on the tenant. In the case of a net lease for instance, you may have to engage a cleaning company, pay the bills directly, and deal with any problems yourself. It would be far easier if you could just call the owner when your trash is not picked up. After all you have a business to run, do you really want to find out why the cleaning person didn't clean the bathroom last night

 

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