Commercial Rent—Options and How to Calculate Them
The Benefits of Commercial Tenants and How to Negotiate a Good Lease
Commercial and retail leases use various rental pricing methods. The nature of a tenant's business often determines which commercial lease calculation is best to use.
The economy can also play a part as well, balancing a need to retain an occupant with the occupant's ability to pay based on its revenues. Retail business revenues can vary significantly in a given year from seasonal or just demand cycles. Some leases work well for varying incomes, allowing tenants to make reduced lease payments during lower revenue periods.
The Benefits of Commercial Tenants
Investors with only residential single-family rental properties often hesitate to get into commercial leasing because it's more complicated, but it can be well worth the extra education. Commercial tenants are generally more business-oriented and experienced in leases, and they often hire real estate professionals or attorneys to handle their lease activities if they're not.
Economies change, and sometimes commercial leases provide a much better return than residential lease property.
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 and there's no other option. Capturing a good tenant in an office or retail space can mean many years of dependable rental income and positive cash flow.
This is especially true if the space is located in a high traffic area that's supporting a steady flow of business. The tenant will be reluctant to move if it can't be sure it will be able to maintain the level of business it enjoys in its current space.
These tenants often pay for repairs and improvements as well, depending on the type of lease. They tend to take care of the properties very well because they have customers on-site and they want those customers to have a pleasant experience so they'll return.
Rent Per Square Foot
Lease types are often based on the tenant's type of business.
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:
- Annual quote: A 2,200 square foot office space is quoted rent of $11.50 per square foot. This works out to 2,200 X $11.50 = $25,300 per year for rent.
- Monthly quote: Working with the same building and rent for a monthly amount works out to the annual quote of $25,300 divided by 12 months for a monthly rental amount of $2,108.33.
It's common for a landlord to determine a base rent that he absolutely needs in his commercial lease calculation, then have the tenant pay a percentage of its retail gross income in addition to this base rate. Retail sales should rise and enable the tenant's ability to pay higher rent if the location is a good one.
You can calculate the percentage in one of two ways.
Percentage Over Base Amount
The tenant pays a minimum base monthly rent in this case, then adds a percentage of all gross receipts over a certain base amount. For example, base rent might be $1,000 per month, plus 5% of all gross receipts over $50,000 per month.
Using one month's gross receipts of $72,000, the calculation would look like this:
$72,000 - $50,000 = $22,000
$22,000 x .05 = $1,100
$1,100 + base of $1,000 = month's rent of $2,100
Percentage of Gross Receipts
We don't set a bottom-line revenue before the percentage kicks in with this option. Rent is paid on all gross receipts from zero. For example, the tenant might pay $500 a month in base rent, plus 2% of gross business receipts. Using the same numbers as above, the calculation works like this:
$72,000 X .02 = $1,440
$1,440 + $500 = monthly rent of $1,940
The base rent is typically less with this option.
The Bottom Line
Negotiating rent for a commercial space can get quite complicated. A prospective business tenant knows its costs of doing business and its anticipated revenues, and the tenant will want to fit rent into its costs in such a way as to achieve a certain level of profit. The property owner knows his costs of ownership and what he needs to receive in the way of rent to assure a positive cash flow. A win-win is often the result.