Occupancy cost is typically one of the largest expenses you face as a business owner. So, it is very important that you consider each component of occupancy carefully before making a decision on which building you decide to lease.
To be sure, the ‘coupon’ or ‘base’ rate you pay is the biggest chunk of your overall cost, and lease rates have been on the rise since the so-called Great Recession ended nearly a decade ago.
A building that may have leased for 50 cents per square foot in 2010 would lease for roughly twice that amount today, and lease rates are still heading north. That is mainly due to higher demand for space from growing companies and the dwindling supply of existing buildings that has sent the vacancy rate into the 2% range. In previous economic up-cycles developers responded by adding new supply to meet the rise in demand. This time around that has not been the case.
The delivery of new inventory has been running at a trickle due to the extraordinary cost of what little land is left to build on.
In fact, the price of land has risen so much that traditional industrial developments are, for the most part, no longer feasible in most Southern California submarkets. That simple fact has been a blessing to existing property owners and a curse to business owners like you who need quality functional space to operate efficiently.
Take Garden Grove as an example. Since 1988, not a single new industrial project has been built. So, prospective tenants there are left to choose from a smattering of available buildings, each of which is at least 31 years old. In fact, there are only 2 cities in all of Orange County that have any new space under construction.
Unfortunately, this trend is certain to continue and when you next face your next relocation event, you can count on occupying an aging facility at a high coupon rate. But, that is not the only cost to be looking out for. Most leases call for the tenant to maintain all or nearly all components of the building. In a net lease, you pay for everything, just as if you owned the building yourself. So, if you lease a facility with aging building systems like the roof and HVAC systems, chances are you will spend more on basic maintenance throughout the lease.
This makes clear the importance of fully inspecting that facility and insisting on seeing maintenance records before you commit to it, so that you have the opportunity to negotiate with the landlord to deliver the property in good condition at the start of your lease. It may cost you a few bucks up front, but it could save you thousands down the road. If you do discover aging systems that have been poorly maintained or are already beyond their useful life, you may be able to carve responsibility for them out of the lease, which will lower your overall occupancy cost.
The tax basis of each property you are considering is another major component of occupancy cost. If you lease on a net basis, you will be responsible for the entire tax bill. So, what the landlord paid for his building will determine what that cost will be. If he bought it last year, the taxes will be more than double what they would be if he bought it ten years ago, as Proposition 13 sets the base levy at the point of acquisition.
At today’s price point, just the property tax bill could add more than 20 cents per square foot per month to your occupancy cost. That same building purchased 10 years ago would have a property tax bill of 12 to 13 cents per square foot per month.
There are several more components of occupancy cost that you should take into consideration before you make your decision. We will explore those in a subsequent post. Stay tuned. If you’d like to learn more, just give us a call. We are here to help.