How to Calculate Commercial Rent
Commercial and retail leases use various rental pricing methods. The decision as to which commercial lease calculation method to use is frequently related to the type of tenant business. It could also have to do with the economy, balancing a need to retain an occupant with their ability to pay based on their business revenues. Retail business revenues can vary significantly in a given year, whether from seasonal or just demand cycles. Some leases work well for varying income, allowing the tenant to pay lower lease payments during lower revenue periods.
Economies change, and sometimes commercial leases provide a much better return than residential lease property.
Investors with only residential single-family rental property experience often hesitate to get into commercial leasing, as it is more complicated. It can be well worth the extra education, however. Commercial tenants are generally more business-oriented and experienced in leases. If not, they often hire real estate professionals or attorneys to handle their lease activities.
Commercial rental properties include shopping malls, professional offices, strip centers, and free-standing buildings used for offices and retail space. Successful businesses are reluctant to change location unless more space is needed. Capturing a good tenant in an office or retail space can mean years of dependable rental income and positive cash flow. This is especially true if space is located in a high traffic area supporting a steady flow of business. The tenant will be reluctant to move when they aren't sure they'll maintain the level of business they enjoy in their current space.
Depending on the type of lease, the tenant often pays for repairs and improvements. They take care of the property, as they have customers on site. They want them to have a pleasant experience so they'll return. There are very different lease types, and they often are based on the type of tenant business. Let's look at these lease types, how they work, and how they're calculated.
Rent Per Square Foot
Rent is set at $xx.xx per square foot of the leased space. This can be expressed either as an annual or a monthly amount.
- Example with annual quote: A 2,200 square foot office space is quoted a rent of $11.50 per square foot. 2,200 X $11.50 = $25,300 per year for rent.
- Example, same building and rent for monthly amount: 2,200 X $11.50 = $25,300. Divide by 12 months to get a monthly rental amount of $2,108.33.
Retail volume can vary significantly due to many factors, including the economy and also location. For this reason, it is a common practice for a landlord, in their commercial lease calculation, to determine a base rent that they absolutely need, and then to have the tenant pay a percentage of their retail gross income in addition to the base rate. This is logical because, if the location is a good one, retail sales should rise and enable the tenant's ability to pay higher rent. There are two ways in which the percentage is normally calculated:
1. Minimum base rent + percentage over a certain base amount: In this case, the tenant pays a minimum base monthly rent, and then adds a percentage of all gross receipts over a certain base amount. Example: $1,000 per month base rent, and 5 percent of all gross receipts over $50,000 per month. Using one month's gross receipts of $72,000, we do the calculation this way:
$72,000 - $50,000 = $22,000
$22,000 x .05 = $1,100
$1,100 + base of $1,000 = month's rent of $2,100
2. Minimum base rent + percentage of all gross receipts: Here, we don't set a bottom line revenue before the percentage kicks in. Rent is paid on all gross receipts from zero. Example: $500 base rent + 2 percent of gross business receipts. If we use the previous numbers, we'd take 2 percent of the entire $72,000 and add that to the base rent, as here:
$72,000 X .02 = $1,440
$1,440 + $500 = monthly rent of $1,940
The negotiation of rent for a commercial space can get quite complicated. The prospective business tenant knows their costs of doing business and anticipated revenues. They will want to fit rent into their costs such that they can count on a certain level of profit. The property owner knows their costs of ownership and what they need to get for rent to assure a positive cash flow. A win-win is the usual result in commercial lease negotiations.